One Up on Wall Street | Peter Lynch

Published in: 1989

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Peter Lynch is the fund manager who made himself known for his ability to identify interesting investments in everyday life – often companies that sold products or services that he himself appreciated. As manager of the Magellan Fund at Fidelity Investments between 1977 and 1990, Lynch had an average annual return of 29.2%, more than double the S&P 500. Assets under management increased from $18 million to $14 billion in 13 years.

A SHARE IS A PIECE OF THE BUSIESS. If a company does better than expected, the stock will perform well. If you own a company that continues to increase profits, it will probably be a good investment given that you have not paid too high a multiple.

PREPARATION IS KEY. Before you buy stocks, decide if you trust capitalism what you expect from stock and if you are short or long term oriented. It is personal preparation, as much as knowledge and research, that distinguishes a successful stock picker from a chronic loser.

STOCKS OR BONDS? Despite crashes, depressions, wars and recessions, equities have yielded an average of 15x corporate bonds and more than 30x treasury bills. The explanation is that the investor has the company’s growth on his side. Anyone who lends money to companies can at best get their money back plus interest. At the time the book was written, corporate profits had risen 55x since WWII and the stock market had risen 60x.

HAVE MORE RIGHT THAN WRONG. Six out of ten winners in a portfolio can give outstanding results. Losses are limited (-100%) while gains do not have the same limitation. The more right you are about a stock, the more wrong you can be about the others and still succeed as an investor. On Wall Street, a “tenbagger” is a stock you earned 10x your money on. Finding such a company (in everyday life) is the first step. The next step is to do research. Invest in what you understand. The grassroots observer can note a turnaround 6-12 months earlier than regular financial analysts.

EARNINGS, EARNINGS, EARNINGS. If you’re only going to follow one data point: follow the profit. The first step is to set the market value in relation to the profit (P/E ratio). This ratio says something about the market’s expectations on the future (high P/E ratio usually means high expectations and vice versa). A company valued at P/E 2 means that it takes two years to recoup your initial investment. However, gains are not constant and judging them is an art form rather than a mathematical science. There are five ways a company can increase its profits: (1) reduce costs, (2) raise prices, (3) expand into new markets, (4) sell more in existing markets, or (5) revitalize.

NOT AN EXACT SCIENCE. You can at best have a qualified guess about future earnings. The fact that a share can go down even though the profit has gone up, means that analysts and followers thought that the profit would be even higher. These are short-term anomalies.

IGNORE THE HYPE. Avoid the hottest company in the hottest industry, these will be expensive and attract competition. Also avoid companies that are described as “the next Disney” or similar. Also avoid companies with flashy names as well as companies that are heavily dependent on a single customer.

DO NOT DISCUSS HORSE TEETH. Never invest in a company until you have done your homework on profit opportunities, financial position, the competitive situation and expansion plans. Many operate as the early Greeks who could sit for days and discuss how many teeth a horse has. They thought they could come up with the answer, but never went out to the stable to open the horse’s mouth and check it out. Investing without research is like playing poker without looking at the cards. Before you buy a stock, you should be able to have a two-minute dialogue that describes the investment case.

IT’S A LONG-TERM GAME. Homes, just like stocks, are most profitable when owned over a long period of time. Inherent qualities within us humans make us bad market timers, which partly explains why many people make money on housing but not in the stock market. It is only by sticking to a strategy through good as well as bad years that you maximize your long-term results.

THE FAVORITE COMPANIES. Lynch believes that the best stocks to own are situations such where you have an edge and have discovered a good opportunity that is able to pass the test in your analysis. Lynch’s favorite companies are those that (1) sound boring or creepy, (2) deal with something boring, (3) sell something that is disgusting – though not unethical, (4) spin-offs, (5) institutions do not want to own it and analysts do not want to follow it, (6) there is something depressing about it, (7) they operate in an industry that is not growing, (8) they have a niche, (9) people must want to buy the product, (10) it is a user of technology, (11) insiders buy and (12) the company buys back shares.

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