Four Stocks Peter Lynch Would Like

Substitution in the current economy takes place whenever any consumer decides to buy one product in place of another because:

• He wants to save money.

• He wants to maintain as much of the psychological pleasure of buying the higher-priced product as possible.

Substitution is about finding a way to get the same kinds of ego gratification, personal fulfillment and emotional pleasure out of consuming as we get now, but at a lower cost. (Substitution is actually a fairly hopeful state because it indicates consumers are not so worried about the future that they're looking to reduce spending at any cost.)

The Substitution Solution

Substitution can take place at any price point. At the upper end, a wine lover decides not to spend an extra $20 or $30 on a bottle of red wine with a rave rating from one of the wine magazines because an $18 no-name red is just as satisfying. That's substitution. Further down the price scale, deciding to buy a new pair of earrings to freshen up a familiar outfit rather than buying an entirely new ensemble is substitution.

Substitution doesn't mean denial. Far from it. After all, the consumer is still buying something.

But the change in what's being bought is enough to throw a consumer sector into turmoil. When consumers substitute one product for another (store-brand crackers for, say, Wheat Thins), new winners emerge, and some companies inevitably lose. Remember that substitution is close to a zero-sum game. Companies positioned by luck or skill to catch the direction of a substitution can ride the trend a long way -- sometimes all the way to permanent gains in market share. Companies with competitive advantages such as flexible pricing, lean inventories and just-in-time marketing gain an even bigger edge during a substitution economy.

The Amateur's Edge

Going back to Peter Lynch's original point, amateur investors do have an edge in separating the substitution winners from the losers. Your own reaction to the complexities of psychological value in this economy may well be the best place to start looking for attractive stocks. And that's a significant edge as investors try to figure out where the current economy and stock market might be headed. (I concede it's dangerous to generalize from your own individual behavior to that of consumers as a whole.)