This is the continuation of Peter Lynch’s six types of companies.
If you’re interested to know about the first three, please click HERE.
4. Cyclicals
Cyclicals are companies in industries that experience frequent booms and busts.
As such, they display distinct patterns in their sales and profits depending on which stage of the cycle they are on.
“Hard” commodities such as oil and gas and “soft” commodities such as coffee and grain are examples of cyclical industries.
For example, oil and gas companies enjoy a surge in revenue and profits when oil prices skyrocket.
When oil prices plunge, profits will likely follow suit as well.
Hence, investing in cyclicals carries a certain amount of risk due to this volatility.
One should be very familiar with the cyclical peaks and troughs within the industry in question before attempting to invest in a company within it.
Even then, external factors could influence the cycle in ways that are difficult to predict, thereby increasing the risks of either a longer-than-expected bust or a permanent and adverse structural shift.
5. Asset Plays
Asset plays are companies that hold assets which can be readily converted into cash.
Examples of such assets include real estate, specialised equipment, or even shares in other companies.
Companies with excess cash can also be seen as asset plays.
Such companies are often underappreciated by the market as many investors prefer to gun for growth.
Value investors, however, look to purchase asset plays with a view to one day unlocking the value of these valuable assets.
Walmart Inc (NYSE: WMT), the multinational retail corporation, owns significant amounts of land, building and equipment worth US$92.2 billion as of 31 January 2021.
Besides that, the retailer also has an abundance of cash on its balance sheet.
As of 31 January 2021, Walmart had US$17.7 billion of cash and cash equivalents.
When added together, these assets plus cash amount to nearly US$110 billion, making up more than a quarter of the retailer’s market capitalisation.
Finding asset plays, however, may not be easy.
Often, the market accurately appraises the value of these companies’ assets, with not much of a bargain left for the intrepid investor.
6. Turnarounds
Turnarounds are companies that previously went through a rough patch for various reasons.
It could be due to a wrong investment move, lack of liquidity or external factors (i.e. disasters, recession or war).
After successfully overcoming these challenges, these companies are now turning their losses into profits.
Investors hunt for turnarounds as such companies are cheaply-priced due to the financial distress they face.
These investors also want to benefit from their growth later on.
FedEx Corporation (NYSE: FDX) was on the brink of bankruptcy and was saved only after founder Fredrick Smith resorted to gambling in order to fund the business.
It was, admittedly, a reckless move. But luckily for Smith, it paid off.
Today, the company is worth around US$79 billion.
However, things are not always rosy.
Such companies still face the risks of falling back to where they started.
It is definitely not an easy feat for management or the business to salvage a bad situation.
Some plans may work out in the short-term, but the business still faces the question of long-term viability.
Turnarounds are, therefore, a category of businesses that entail significant risks.
Get Smart: A well-balanced portfolio
Lynch was able to produce phenomenal returns on his investments as he knew the risks and characteristics inherent in each category of companies.
These categories offer different options to investors based on their personal investment goals.
A young investor with a higher risk appetite may be more inclined to explore businesses that have potential for high returns.
But if you are a retiree, your aim may just be the enjoyment of a constant dividend stream that can last you through your retirement.
Because of this, you may be unwilling to take as much risk.
Hence, you should be conscious of the risks and rewards for each category of company described above.
Being aware of your personal investment goals allows you to choose the appropriate category of company that will work best for your investment portfolio.
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Disclaimer: Jia Yi does not own shares in any of the companies mentioned.