How a Passive Investment Strategy Wins Big

This article is an excerpt from the Shortform book guide to "One Up On Wall Street" by Peter Lynch. Shortform has the world's best summaries and analyses of books you should be reading.

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What types of stock shares are there? What are some things you should consider when deciding what stocks are right for you?

There are several different classifications of stock shares. Peter Lynch divides all stocks into six categories. The stocks that will be suitable for you depend on your investing ambitions and your risk tolerance.

Keep reading to learn about the six different types of stocks, according to Peter Lynch.

There Are Different Types of Stocks

Companies fall into one of six stock types and often change type over time, says Lynch. How you invest in a stock depends on what type of stock it is, and it’s important to understand the type before you invest. This ensures you have correct expectations of that company’s performance and won’t sell a stock in a company type prematurely. 

(Shortform note: Lynch stresses the importance of managing your expectations of your stock performance by understanding the maximum possible performance of the stock. Expectation management is an important skill to build and apply in all realms of life, including investing, to avoid difficulty and conflict. One piece of advice on managing expectations at work is to never assume you or others fully understand a project or topic of conversation—always seek clarification to ensure everyone’s on the same page. You might apply this advice to your trading: Never assume you know what an unfamiliar piece of information about a stock means and instead seek full clarification.)

According to Lynch, there are six different types of stocks:

1. Slow-Growth Companies

Most companies that start out as fast growers eventually become slow growers. Lynch doesn’t particularly recommend investing in slow-growth companies because you won’t make money fast.

(Shortform note: While Lynch frames slowed growth as an unfortunate eventuality for fast-growth companies, others advise fast-growth companies to actually consider slowing their growth. This is because doing so can help the company firm up its foundation, set realistic goals, and predict future events—and all this can help it maintain momentum in the long run.)

2. Dependable Companies

These are large, established companies that grow more quickly than slow-growth companies but still maintain a relatively slow pace. It’s good to have a few dependables in your portfolio because they’ll keep you afloat in market downswings since they generally aren’t as strongly impacted by such swings as smaller companies are. 

(Shortform note: In The Intelligent Investor, Graham strongly recommends investing in dependable companies, which he describes as large, prominent companies with conservative financing. Graham clarifies that such a company should have at least $10 billion in market capitalization, be an industry leader, and have a market capitalization no greater than twice its value.)

3. Fast-Growth Companies

These companies are small and grow aggressively, at 20 to 25% per year. Such companies also tend to be tenbaggers or higher. These companies are riskier than dependable companies. 

(Shortform note: Fast-growth companies these days tend to be tech start-ups. Such companies are almost compelled to grow extremely aggressively because the first mover generally captures the entire market, making speed more important than careful planning.)

4. Cycle Companies

These are companies that grow and contract in cycles. Such companies can be dangerous for inexperienced investors if they don’t understand when’s the best time to invest and that a downswing will be followed by an upswing. 

5. Underdog Companies

These are companies that are experiencing a low-growth moment but will soon make a rapid comeback and are therefore worth investing in when stocks are low. 

(Shortform note: Lynch discusses cycle and underdog stocks but doesn’t explain how to identify them or how to know when they’re about to resurge. This may raise the question: Wouldn’t a person with more education on these matters—for example, an MBA in finance—have an advantage as an investor? And, assuming the answer is yes, does that point to a flaw in Lynch’s argument that an average person can have as much success as a professional investor?)

6. Hidden-Treasure Companies

These are companies that have an asset you happen to know about but which professional investors have overlooked. An asset might be cash, real estate, a subscription model, or some other hidden advantage. It takes inside knowledge to know this advantage. 

(Shortform note: In Naked Economics, Charles Wheelan goes against Lynch’s belief in hidden-treasure companies by asserting that it’s unlikely that you’ll ever have special information about a company that other investors don’t have. This is simply because there are too many investors out there looking for the same hidden treasures as you.)

Most companies change stock types over time. Fast-growth companies eventually slow down or might become cycle companies. Alternatively, a slow-growth company might become an asset play when clued-in investors recognize it owns good real estate. Any slow-growth company might become an underdog. 

(Shortform note: Where can you find information about changes in a company’s stock type so you can make savvy trading decisions? These days, there are a variety of sites and apps that can keep you updated (though these won’t specifically tell you when a company changes stock type, as stock types are a construct of Lynch’s; rather, they’ll provide news about a company’s fortunes so you can draw your own conclusions about how its type is changing): The Wall Street Journal app, the Bloomberg: Business News Daily app, and TheStreet – Investing News app are just a few.)

An Alternative to Stocks: Cryptocurrency

Beyond the stock types Lynch mentions here, there’s an entirely different type of investment that’s emerged and grown popular in the last few decades: cryptocurrency, a digital currency you can trade like stocks. 

Buying cryptocurrency, as opposed to company stock, might appeal to you if you have a high risk tolerance: Crypto is generally considered to be a risky investment. You might also wish to invest in crypto if you want to use that asset more flexibly than merely being able to buy and sell it—you can earn profit from non-trading activities like yield farming, and you can extract nonmonetary value from a crypto token (like special access to your favorite sports team). 

Still, as appealing as cryptocurrency might seem, it’s likely advisable to invest in both crypto and traditional stocks to diversify your portfolio and mitigate risk. 
The 6 Different Types of Stocks You Need to Know

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Darya Sinusoid

Darya’s love for reading started with fantasy novels (The LOTR trilogy is still her all-time-favorite). Growing up, however, she found herself transitioning to non-fiction, psychological, and self-help books. She has a degree in Psychology and a deep passion for the subject. She likes reading research-informed books that distill the workings of the human brain/mind/consciousness and thinking of ways to apply the insights to her own life. Some of her favorites include Thinking, Fast and Slow, How We Decide, and The Wisdom of the Enneagram.

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