Peter Lynch is an American investor and mutual fund manager. He was the rock star manager of the “Magellan Fund” at Fidelity Investments between 1977 and 1990. Lynch average a 29.2% annual return, doubling the S&P 500 Stock market index. He made Magellan Fund, the best performing mutual fund in the world. During this 13-year tenure, the Assets under Management increased from $18 million to $14 billion.
If you had invested $10,000 in 1977 and not added any further capital, in 1990, this would have turned into $279,519.86! That is the magic of compounding that an exceptional manager of capital can generate. He picked up winners like Dunkin Donuts, Fannie Mae, Ford, Philip Morris, MCI, Volvo, General Electric and Lowe’s. His investing strategy is growth combined with value. “GARP” (Growth At A Reasonable Price) is the strategy where growth investing marries the discipline of value investing. He also termed the phrase “ten bagger” which refers to a stock that has increased tenfold in price.
Investment Strategy
His basic premise is “invest in what you know” (your circle of competence). This is where the regular has a one up on the Wall Street pro. Every day, we use many products and services, but never pay attention to what companies are behind these, what their financial status is. But these companies usually are not on the radar of Wall Street analysts. By gauging the public sentiment about the products and applying domain knowledge about the market, the novice can purchase these stocks when the market is sleeping. On a side note here, please remember that a good product does not always equate a good stock, but it would be a good point to start investigating further.
Peter Lynch states that philosophy and logic are more important than math or finance in picking stocks. He observed that the academic theories of efficient market hypothesis, were being disproved regularly by professionals he saw at Fidelity. Warren Buffet famously quoted that he would be a bum on the street with a tiny cup if the markets were almost efficient!
Books
Peter Lynch has written three texts on investing: “One Up on Wall Street”, “Beating the Street” and “Learn to Earn”. He has laid out his investing principles in these books. I read “One Up on Wall Street” cover to cover and his writing style is so enjoyable and down to earth, without all the financial jargon. He brings to life the large companies that we see today in the market, that once started small and obscure. In this book, he has listed twelve things which amateurs and professionals say about stock prices but which are dead wrong. He has explained these in great detail with the examples from the stocks of that time. The following is the list:
- If it’s gone down this much already, it can’t go much lower
- You can always tell when a stock’s hit bottom
- If it’s gone this high already, how much can it possibly go higher?
- It’s only $3 a share: what can I lose?
- Eventually they all come back
- It’s always darkest before the dawn
- When it rebounds to $10, I will sell
- What me worry? conservative stocks don’t fluctuate much
- It’s taking too long for anything to ever happen
- Look at all the money I’ve lost: I didn’t buy it
- I missed that one, I’ll catch the next one
- The stock’s gone up, so I must be right, or… the stock’s gone down, so I must be wrong
I got the idea of updating the examples that were listed with the current companies so it’s a bit easier to understand in today’s context. So here we go:
If it’s gone down this much already, it can’t go much lower
Blockbuster LLC was a provider of home movie and video game rental services. At its peak in 2004, the company had 9,000 stores and employed more than 80,000 people worldwide. From its peak of $27 in 2002, it fell steadily and now trades in the OTC market for $0.0041. The arrival of discount movie rentals like RedBox and streaming service of Netflix relegated this once giant company to bankruptcy.
Circuit City, the electronics retailer, was trading at a peak of $30 in May 2006 and fell to $8 in December 2007. Many people thought how much lower could it go. Some even doubled down the shares at this price. Then it fell to 10 cents a share in November 2008! There were many mistakes made in the operations of the company. The locations chosen were not prime and most of them had either a Best Buy or Walmart at a stone throw’s distance. The customer service was very bad. The working capital was getting stuck in inventory due to bad inventory management, thus giving no cash flow.
You can always tell when a stock’s hit bottom
This is called bottom fishing, where investors try to scoop shares when the price hits bottom. But no one actually knows what the bottom is! A lot of times, falling stocks are like falling knives. If you grab them, your portfolio may take a big hit. It usually takes two to three years for the price to bottom out and if the company has a good balance sheet and prospects, the price may then start an upward march.
When the pandemic hit, a lot of stocks fell and suddenly a lot of bargains were to be found. I scooped the shares of Kohls a bit early when they were a bit lower than $30. They did not stop there but continued to go down to settle at near $10 before they started their way back up. A good learning and humbling experience!
If it’s gone this high already, how much can it possibly go higher?
Microsoft (MSFT) is a classic example where it was lingering in the $20s for quite some time. The company was going nowhere in terms of business strategy with the old PC licensing model looking outdated. It had a decent market cap and no one expected it to grow any further. MSFT had seen its day and had turned into a slow behemoth company. Enter Satya Nadella, the dynamic CEO who steered it in the direction of the cloud and with it, the stock price also entered the cloud! Every time I see the price, I always think how much higher can it grow, and it always keep climbing higher. I still have not been able to purchase a single stock but that is for another blog post.
The important thing is to check the fundamentals and the growth story. If they are sound and you find a long runway ahead in terms of growth, grab the stock with both hands.
It’s only $3 a share: what can I lose?
JCPenney is a company that never fails to lure big investors. Bill Ackman got into it at $25 a share, looking at the real estate holdings of the company. He brought in Ron Johnson, who had designed the Apple retailing stores. He lost close to $500 million on his initial $900 million investment. When the price came down to $3, there were a few value investing funds that brought a stake and rode up to $5 a share. But then the slide started again and fell around $1 a share. Recently the company has filed for bankruptcy protection and has been delisted. It is trading for around 25 cents a share. An investor who bought at $25 has lost 99% and the one who has bought it for $3 a share has lost around 93%. Big consolation! The point is that a cheap lousy stock is just as risky as a lousy expensive stock if it goes down. The short sellers also like to take positions in stocks closer to $3 than at the $30 levels, since they make the exact same profit from both trades percentage wise when it goes down.
Eventually they all come back
Radio Shack, Kodak, Pets.com are all examples of companies that went bankrupt and never came back. Enron is the symbol of corporate fraud and corruption and its bankruptcy in 2001 is the largest in the U.S. history.
It’s always darkest before the dawn
In 2014, U.S. Shale oil created a boom in domestic oil production propelling United states to become the number one crude oil producer. When the oil prices fell back in 2015, the producers just kept pumping more oil to make their payments. Low interest rates meant the companies could survive by servicing the interest on their debt and refinancing. The hope always was that they would eventually come back. This time around, with the oil price falling due to oversupply from Saudi Arabia and Russia, there is no sighting of the dawn. There is no fat to cut around balance sheets as companies are already operating with minimum costs and there is so much money that could be borrowed. Around 200 companies have gone bankrupt between 2015 and present, and the current economic situation does not look promising at all.
When it rebounds to $10, I will sell
A recent example is of Macys (M) when it slid to $5 levels. There was a pop in the stock price and it took off to reach almost $10 a share. I was waiting for it to hit that mark, but I read Lynch’s recommendation: If you will not buy the shares at this price, you should never hold it. I sold off and thankfully got out before it started reaching the $5 levels. So never stick on to a stock to reach a certain number because it may never reach and you will be holding losses in your portfolio that get worse every day.
What me worry? conservative stocks don’t fluctuate much
Companies are dynamic and the prospects keep changing. There is not a company that you can own and afford to ignore. Again, many airlines which kept growing until recently were such a safe bet. They paid handsome dividends and the industry just kept growing. Enter the pandemic and no one knows what the future of the airlines stocks is.
It’s taking too long for anything to ever happen
It takes lots of patience to be a good investor. It is like watching the paint dry! How boring but investors who have this virtue are handsomely paid. It takes anywhere from 5 to 10 years for a company to realize the fruits from the good seeds it has sowed. Take the case of Amazon, so many bold bets were made without worrying about the short-term price movements of the stock. Ben Graham, the mentor of Warren Buffet famously said, “In the short term, the stock market is a voting machine but in the long term, it is a weighing machine.”
Look at all the money I’ve lost: I didn’t buy it
All of us would be much richer today if we had put all our money in Amazon, Facebook, Netflix, Microsoft or Alphabet (Google). This is not a productive attitude to count other’s gains as personal losses. No one would ever be happy that way. So do not torture yourself with these thoughts but keep your eyes and mind open for new ideas and you will hit that home run sooner rather than later.
I missed that one, I’ll catch the next one
You missed Tesla (TSLA) stock and you are beating yourself. Then you find out about NIO stock. Both are electric vehicle producers and you double down on NIO hoping to catch up with missing TSLA. But today, TSLA is flying high with meeting its deliverable targets and raising capital whereas NIO is fighting for survival. In most cases, it is better to buy the original good company (I’m not sure about TSLA though on this one) rather than buying the “next big one” at a bargain price. You are not compounding your gains rather you are compounding your losses!
The stock’s gone up, so I must be right, or… the stock’s gone down, so I must be wrong
Lynch says this is the great single fallacy of investing. When you pick a stock at $10 and it goes up to $12, you pat on yourself on your back that you have made a good choice. If you do not sell at that time thinking that the prospects are good, and it goes down to $8, then you have made a loss if you sell at that point. The price going up and down just means that there is someone else at the other end who is willing to purchase/sell the stock to you and it gives no idea about the prospect of the company. Many of the high-flying stocks that trade for high prices are just like the game of musical chairs. The shares keep trading and once the music stops, the one holding them will be counting his losses. An example is the Luckin Coffee (LK) which got delisted recently due to scandals.
Conclusion
Thus, we come to the end of the list and I personally was able to relate to a lot of these mistakes and learnt a lot about recognizing these when I go through them in investing. We all are bound to make mistakes, but the important thing is to learn from these and not forget the lesson.