by Peter Lynch
Countries have a growth rate (the GNP), industries have a growth rate, and so does an individual company. Whatever the entity, “growth” means that it does more of whatever it does this year (make cars, shine shoes, sell hamburgers) than it did last year. President Eisenhower once said that “things are more like they are now than they ever were before.” That’s a pretty good definition of economic growth.
Keeping track of the growth rates of industry is an industry in itself. There are endless charts, tables, and comparisons. With individual companies it’s a little trickier, since growth can be measured in various ways: growth in sales, growth in profits, growth in earnings, etc. But when you hear about a “growth company,” you can assume that it’s expanding. There are more sales, more production, and more profits in each successive year.
The growth of an individual company is measured against the growth of the economy at large. Slow-growing companies, as you might have guessed, grow very slowly—more or less in line with the nation’s GNP, which lately has averaged about three percent a year. Fast-growing companies grow very fast, sometimes as much as 20 to 30 percent a year or more. That’s where you find the most explosive stocks.
Three of my six categories have to do with growth stocks. I separate the growth stocks into slow growers (sluggards), medium growers (stalwarts), and then the fast growers—the superstocks that deserve the most attention.
THE SLOW GROWERS
Usually these large and aging companies are expected to grow slightly faster than the gross national product. Slow growers didn’t start out that way. They started out as fast growers and eventually pooped out, either because they had gone as far as they could, or else they got too tired to make the most of their chances. When an industry at large slows down (as they always seem to do), most of the companies within the industry lose momentum as well.
Electric utilities are today’s most popular slow growers, but throughout the 1950s and into the 1960s the utilities were fast growers, expanding at over twice the rate of GNP. They were successful companies and great stocks. As people installed central air conditioning, bought big refrigerator/freezers, and generally ran up their electric bills, electricity consumption became a high-growth industry, and the major utilities, particularly in the Sunbelt, expanded at double-digit rates. In the 1970s, as the cost of power rose sharply, consumers learned to conserve electricity, and the utilities lost their momentum.
Sooner or later every popular fast-growing industry becomes a slow-growing industry, and numerous analysts and prognosticators are fooled. There’s always a tendency to think that things will never change, but inevitably they do. Alcoa once had the same kind of go-go reputation that Apple Computer has today, because aluminum was a fast-growth industry. In the twenties the railroads were the great growth companies, and when Walter Chrysler left the railroads to run an automobile plant, he had to take a cut in pay. “This isn’t the railroad, Mr. Chrysler,” he was told.
Then cars became the fast-growth industry, and for a time it was steel, then chemicals, then electric utilities, then computers. Now even computers are slowing down, at least in the mainframe and minicomputer parts of the business. IBM and Digital may be the slow growers of tomorrow.
It’s easy enough to spot a slow-grower in the books of stock charts that your broker can provide, or that you can find at the local library. The chart of a slow grower such as Houston Industries resembles the topographical map of Delaware, which, as you probably know, has no hills. Compare this to the chart of Wal-Mart, which looks like a rocket launch, and you’ll see that Wal-Mart is definitely not a slow grower (see accompanying charts).
Another sure sign of a slow grower is that it pays a generous and regular dividend. As I’ll discuss more fully in Chapter 13, companies pay generous dividends when they can’t dream up new ways to use the money to expand the business. Corporate managers would much prefer to expand the business, an effort that always enhances their prestige, than to pay a dividend, an effort that is mechanical and requires no imagination.
This doesn’t mean that by paying a dividend the corporate directors are doing the wrong thing. In many cases it may be the best use to which the company’s earnings can be put. (See Chapter 13.)
You won’t find a lot of two to four percent growers in my portfolio, because if companies aren’t going anywhere fast, neither will the price of their stocks. If growth in earnings is what enriches a company, then what’s the sense of wasting time on sluggards?
THE STALWARTS
Stalwarts are companies such as Coca-Cola, Bristol-Myers, Procter and Gamble, the Bell telephone sisters, Hershey’s, Ralston Purina, and Colgate-Palmolive. These multibillion-dollar hulks are not exactly agile climbers, but they’re faster than slow growers. As you can see in the chart of Procter and Gamble, it’s not as flat as the map of Delaware, but it’s no Everest, either. When you traffic in stalwarts, you’re more or less in the foothills: 10 to 12 percent annual growth in earnings.
Depending on when you buy them and at what price, you can make a sizable profit in stalwarts. As you can see on the Procter and Gamble chart, the stock has performed well throughout the 1980s. However, if you’d bought it back in 1963, you only made fourfold on your money. Holding a stock for twenty-five years for that kind of return isn’t a very exciting prospect—since you’re no better off than if you’d bought a bond or stuck with a cash fund.
In fact, when anyone brags about doubling or tripling his money on a stalwart (or on any company, for that matter), your next question ought to be: “And how long did you own it?” In many instances the risk of ownership has not resulted in any advantage to the owner, who therefore took chances for nothing.
In the market we’ve had since 1980 the stalwarts have been good performers, but not the star performers. Most of these are huge companies, and it’s unusual to get a tenbagger out of a Bristol-Myers or a Coca-Cola. So if you own a stalwart like Bristol-Myers and the stock’s gone up 50 percent in a year or two, you have to wonder if maybe that’s enough and begin to think about selling. How much can you expect to squeeze out of Colgate-Palmolive? You aren’t going to become a millionaire off it the way you could have with Subaru, unless there is some startling new development you would have heard about by now.
Fifty percent in two years is what you’d be delighted to get from Colgate-Palmolive in most normal situations. With the stalwarts you have to consider taking profits more readily than you would with a Shoney’s, or a Service Corporation International. Stalwarts are stocks that I generally buy for a 30 to 50 percent gain, then sell and repeat the process with similar issues that haven’t yet appreciated.
I always keep some stalwarts in my portfolio because they offer pretty good protection during recessions and hard times. You can see here that during the 1981–82 period, when the country seemed to be falling apart and the stock market fell apart with it, Bristol-Myers went sideways (see chart). It didn’t do that well in the 1973–74 washout as we’ve already seen, but nothing escaped that bath, and besides, the stock was grossly overpriced at the time. In general, Bristol-Myers and Kellogg, Coca-Cola and MMM, Ralston Purina and Procter and Gamble, are good friends in a crisis. You know they won’t go bankrupt, and soon enough they will be reassessed and their value will be restored.
Bristol-Myers has had only one down quarter in twenty years, and Kellogg hasn’t had a down quarter for thirty. It’s no accident that Kellogg can survive recessions. No matter how bad things get, people still eat cornflakes. They may take fewer trips, postpone the purchase of new cars, buy fewer clothes and expensive knickknacks, and order fewer lobster dinners at restaurants, but they eat just as many cornflakes as ever. Maybe they eat more cornflakes, to make up for the lack of lobsters.
People don’t buy less dog food during recessions either, which is why Ralston Purina is a relatively safe stock to own. In fact, as I write this, my colleagues are flocking to the Kelloggs and the Ralston Purinas, since they’re all afraid of a recession right now.<
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THE FAST GROWERS
These are among my favorite investments: small, aggressive new enterprises that grow at 20 to 25 percent a year. If you choose wisely, this is the land of the 10-to 40-baggers, and even the 200-baggers. With a small portfolio, one or two of these can make a career.
A fast-growing company doesn’t necessarily have to belong to a fast-growing industry. As a matter of fact, I’d rather it didn’t, as you’ll see in Chapter 8. All it needs is the room to expand within a slow-growing industry. Beer is a slow-growing industry, but Anheuser-Busch has been a fast grower by taking over market share, and enticing drinkers of rival brands to switch to theirs. The hotel business grows at only 2 percent a year, but Marriott was able to grow 20 percent by capturing a larger segment of that market over the last decade.
The same thing happened to Taco Bell in the fast-food business, Wal-Mart in the general store business, and The Gap in the retail clothing business. These upstart enterprises learned to succeed in one place, and then to duplicate the winning formula over and over, mall by mall, city by city. The expansion into new markets results in the phenomenal acceleration in earnings that drives the stock price to giddy heights.
There’s plenty of risk in fast growers, especially in the younger companies that tend to be overzealous and underfinanced. When an underfinanced company has headaches, it usually ends up in Chapter 11. Also, Wall Street does not look kindly on fast growers that run out of stamina and turn into slow growers, and when that happens, the stocks are beaten down accordingly.
I’ve already mentioned how electric utilities, especially the ones in the Sunbelt, went from being fast growers to being slow growers. In the 1960s plastics was a high-growth industry. Plastics were so much on people’s minds that when the word “plastics” was whispered to Dustin Hoffman in the movie The Graduate, the word itself became a famous line. Dow Chemical got into plastics, enjoyed a vigorous growth spurt, and was beloved as a fast grower for several years. Then the growth slowed down and Dow became a sober chemical company, a sort of plodder with cyclical overtones.
Aluminum was a great growth industry even into the 1960s and so was carpets, but when these industries matured, the companies within them became GNP-type growers, and the stock market yawned.
So while the smaller fast growers risk extinction, the larger fast growers risk a rapid devaluation when they begin to falter. Once a fast grower gets too big, it faces the same dilemma as Gulliver in Lilliput. There’s simply no place for it to stretch out.
But for as long as they can keep it up, fast growers are the big winners in the stock market. I look for the ones that have good balance sheets and are making substantial profits. The trick is figuring out when they’ll stop growing, and how much to pay for the growth.
THE CYCLICALS
A cyclical is a company whose sales and profits rise and fall in regular if not completely predictable fashion. In a growth industry, business just keeps expanding, but in a cyclical industry it expands and contracts, then expands and contracts again.
The autos and the airlines, the tire companies, steel companies, and chemical companies are all cyclicals. Even defense companies behave like cyclicals, since their profits’ rise and fall depends on the policies of various administrations.
AMR Corporation, the parent of American Airlines, is a cyclical, and so is Ford Motor, as you can see by the chart. Charts of the cyclicals look like the polygraphs of liars, or the maps of the Alps, as opposed to the maps of Delaware you get with the slow growers.
Coming out of a recession and into a vigorous economy, the cyclicals flourish, and their stock prices tend to rise much faster than the prices of the stalwarts. This is understandable, since people buy new cars and take more airplane trips in a vigorous economy, and there’s greater demand for steel, chemicals, etc. But going the other direction, the cyclicals suffer, and so do the pocketbooks of the shareholders. You can lose more than fifty percent of your investment very quickly if you buy cyclicals in the wrong part of the cycle, and it may be years before you’ll see another upswing.
Cyclicals are the most misunderstood of all the types of stocks. It is here that the unwary stockpicker is most easily parted from his money, and in stocks that he considers safe. Because the major cyclicals are large and well-known companies, they are naturally lumped together with the trusty stalwarts. Since Ford is a blue chip, one might assume that it will behave the same as Bristol-Myers, another blue chip (see charts). But this is far from the truth. Ford’s stock fluctuates wildly as the company alternately loses billions of dollars in recessions and makes billions of dollars in prosperous stretches. If a stalwart such as Bristol-Myers can lose half its value in a sorry market and/or a national economic slump, a cyclical such as Ford can lose 80 percent. That’s just what happened to Ford in the early 1980s. You have to know that owning Ford is different from owning Bristol-Myers.
Timing is everything in cyclicals, and you have to be able to detect the early signs that business is falling off or picking up. If you work in some profession that’s connected to steel, aluminum, airlines, automobiles, etc., then you’ve got your edge, and nowhere is it more important than in this kind of investment.
TURNAROUNDS
Turnaround candidates have been battered, depressed, and often can barely drag themselves into Chapter 11. These aren’t slow growers; these are no growers. These aren’t cyclicals that rebound; these are potential fatalities, such as Chrysler. Actually Chrysler once was a cyclical that went so far down in a down cycle that people thought it would never come back up. A poorly managed cyclical is always a potential candidate for the kind of trouble that befell Chrysler and, to a slightly lesser extent, Ford.
The Penn Central bankruptcy was one of the most traumatic events that ever happened to Wall Street. That this blue chip, this grand old company, this solid enterprise, could collapse was as startling and as unexpected as the collapse of the George Washington Bridge would be. An entire generation of investors had its faith shaken—and yet once again there was opportunity in this crisis. Penn Central has been a marvelous turnaround play.
Turnaround stocks make up lost ground very quickly, as Chrysler, Ford, Penn Central, General Public Utilities, and numerous others have proven. The best thing about investing in successful turnarounds is that of all the categories of stocks, their ups and downs are least related to the general market.
I made a lot of money for my shareholders by buying Chrysler. I started buying at $6 (unadjusted for later splits) in early 1982 and watched it go up fivefold in less than two years and fifteenfold in five years. At one point I had 5% of my fund invested in Chrysler. While other stocks that I owned have risen higher, no single stock ever had the impact of Chrysler because none ever represented such a large percentage of the fund while it rose. And I didn’t even buy Chrysler at the bottom!
Other more daring Chrysler fans bought in at $1.50 and made a 32-bagger out of it. Either way, Chrysler was a happy occurrence. So was Lockheed, which sold for $1 in 1973, and even after the government bailed out the company you could have bought the stock for $4 in 1977 and sold it for $60 in 1986. Lockheed was one I missed.
In absolute dollars I get my greatest profits from the revival of the Chryslers and the Penn Centrals, bigger companies in which I can buy enough shares to have a meaningful impact on my fund.
It’s not easy to compile lists of failed turnarounds except from memory, because their existence is wiped out of the S&P books, the chart books, and the stockbrokers’ records, and these companies are never heard from again. I could attempt to reconstruct the rather long list of the failed turnarounds I wish I hadn’t bought, except the mere idea of it gives me a headache.
In spite of this, the occasional major success makes the turnaround business very exciting, and very rewarding overall.
There are several different types of turnarounds, and I’ve owned all of them at one time or another. There’s the bail-us-out-or-else kind of turnaround such as Chrysler or
Lockheed, where the whole thing depended on a government loan guarantee. There’s the who-would-have-thunk-it kind of turnaround, such as Con Edison. Who would ever have believed you could lose this much money in a utility, as the stock price fell from $10 to $3 by 1974; and who would have believed you could make this much, as the price rebounded from $3 to $52 by 1987?
There’s the little-problem-we-didn’t-anticipate kind of turnaround, such as Three Mile Island. This was a minor tragedy perceived to be worse than it was, and in minor tragedy there’s major opportunity. I made a lot of money in General Public Utilities, the owner of Three Mile Island. Anybody could have. You just had to be patient, keep up with the news, and read it with dispassion.
After the original meltdown of the nuclear unit in 1979 the situation eventually stabilized. In 1985 GPU announced it was going to start up the sister reactor that had been turned off for years after the crisis but was unaffected by it. It was a good sign for the stock that they got that sister plant back on line, and an even better sign when other utilities agreed to share in the costs of the Three Mile Island cleanup. You had almost seven years to buy the stock after the place calmed down and all this good news had come out. The low of 3⅜ was reached in 1980, but you could still have gotten in for $15 a share in late 1985 and watched the stock hit $38 in October, 1988.
I try to stay away from the tragedies where the outcome is unmeasurable, such as the Bhopal disaster at the Union Carbide plant in India. This was a terrible gas leak that resulted in thousands of deaths, and how much the families would get out of Union Carbide in damages was an open question. I invested in the Johns-Manville turnaround but sold at a modest loss after realizing there was no way to predict the extent of that company’s liability, either.