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In his book “One Up on Wall Street” Peter Lynch mentioned that he puts his stocks into one of 6 categories. I find that this is quite a useful list but I don’t think it’s meant to be exhaustive. Let’s look at what they are:

1. Slow Growers
Slow growers are usually large and aging companies that are expected to grow slightly faster than the economy in general. They probably 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. The classic example he cited are electric utilities.

2. Stalwarts
Stalwarts are companies that would probably do 10-12% annual growth in earnings. The examples he cited include Coca Cola and Proctor & Gamble. But just bear in mind that the book was published some 10 years ago, so the profile of these companies may have changed since then.

3. Fast Growers
Fast growers are small, aggressive new enterprises that grow earnings at 20-25% a year. As long as they can keep it up, Lynch says that fast growers are the big winners in the stock market: “If you choose wisely, this is the land of the 10 to 40 baggers, and even the 200 baggers.” 10 baggers simply mean that the stock price goes up 10 times while 200 bagger (I can’t even imagine this figure) means it goes up 200 times!

The trick is figuring out when such companies will stop growing, and how much to pay for that growth.

4. Cyclicals
Cyclicals are companies whose sales and profits go up and down in a regular or predictable way. It expands and contracts. Think automotive, construction, building materials that sort of thing.

Cyclicals are the most misunderstood stock. An unwary stock picker is most easily parted from his money by investing in stocks that he considers safe. Because major cyclicals are usually large and well know companies, they are usually lumped together with the trusty Stalwarts.

Think Palm Oil. Think IOI Corporation. Not too long ago at RM8 per share with more than RM45 billion market cap, it was still a screaming buy for many research houses out there. What a wake up call they must have received.

Recently I too made a mistake with Maybulk – Malaysian Bulk Carriers. Maybulk’s fortunes are largely tied to the Baltic Dry Index (BDI) which is essentially the shipping rates they get for hiring out their ships. I bought my first batch cheap and did nicely out of it. The BDI went from something like 2,000 to 13,000 points and the company was printing cash. Today the BDI is 829 points.

So where did I go wrong?

In hindsight I was too stubborn to accept that this cash cow is a classic cyclical. But why was I so silly? Because Maybulk management had a great track record and was actually brilliant in trading ships. In addition to normal shipping operations, they would buy and sell ships for a handsome profit. So I thought they could beat the cycle and held on to the stock even at RM5. But at the end of the day, their core operations are still cyclical in nature. So I don’t see them reaching the glory days for quite a while yet.

Timing, Lynch says (and I humbly accept), is everything in cyclicals. You have to detect the early signs that a business is falling off or picking up. If you work in the industry in question, you will have a real edge over other investors – I will talk about this next time.

5. Turnarounds
Turnarounds are those battered and depressed stocks which are near bankruptcy. One of Lynch’s best move was buying Chrysler in early 1982 and watching it go up fifteen times in five years! It was a stock that had one of the greatest impact in his portfolio because it was quite a big chunk of it.

6. Asset Plays
Asset Plays are companies that are sitting on something valuable that you know about, but the stock market has overlooked. Property plays with large undeveloped land in up and coming areas – these are the classic example. Personally I’m not too keen on such stocks unless the asset can generate cash sooner rather than later. So when do you sell an Asset Play? Lynch says that the best idea is to wait for the raider. If there are really hidden assets there, the top raiders will figure it out.

So there you go. If you have share investments, try placing your stock into one of the above categories. It should help you picture what sort of animal you have there and hence the type of buy-sell strategy you can use.

But just a caveat. I find that there are tons of “uninvestable” companies on Bursa Malaysia. Just think companies that are controlled by people who are “not so honest”. I don’t think Lynch has a category for that.

What about Conglomerates?

Well there aren’t many of them nowadays, thankfully.

But the largest company in Malaysia happens to be one of them, so let’s take a look at it. Sime Darby now is a combination of the old Sime Darby, Golden Hope Plantations and Kumpulan Guthrie. Here’s a snapshot of its 5-year earnings growth on a combined basis:

We see that between 2004 to 2008, both EBIT and Net Profit has grown around 20% annually. Quite impressive indeed.

So is Sime a Fast Grower?

I would hardly think so. Looking at its segmental earnings breakdown, plantation profits were a whopping RM3.8 billion or 71% ot its overall business earnings. Sime is essentially a Palm Oil company now with lots of other sidelines such as motor vehicle distribution, property, energy etc. So I would put it as a cyclical stock.

For conglomerate type companies, we need to look at them on a case-by-case basis to see where most of its earnings are coming from.