Peter Lynch – Beating The Street

I had the great pleasure of meeting Tom Gardner, the CEO and co-founder of The Motley Fool, and several other wonderful Fools a few weeks back. Great ideas flowed freely that evening, as did the excellent boutique beer.  Tom’s comment that he learnt something new every time he re-read Peter Lynch inspired me to re-read Lynch’s Beating The Street.  What I love about Lynch is his open minded disposition, as the first two words in this timely piece of advice illustrates, though saying that, it is the advice rather than his open mind that is worth focusing on.

Whatever method you use to picks stocks or stock mutual funds, your ultimate success or failure will depend on your ability to ignore the worries long enough to allow your investments to succeed. It isn’t the head but the stomach that determines the fate of the stockpicker. The skittish investor, no matter how intelligent, is always susceptible to getting flushed out of the market by the brush beaters of doom.

Peter’s Principles

Peter’s Principle #3: Never invest in any idea you can’t illustrate with a crayon.

#4: You can’t see the future through a rearview mirror.

#7 The extravagance of any corporate office is directly proportional to management’s reluctance to reward the shareholders.

#11 The best stock to buy may be the one you already own.

# 14 If you like the store, chances are you’ll love the stock.

The St. Agnes Chorus

Lynch maxims through a seventh-grade filter, once again highlight Lynch’s open mind.

  • Never fall in love with a stock; always have an open mind.
  • Just because a stock goes down doesn’t mean it can’t go lower.
  • You should not buy a stock because it’s cheap but because you know a lot about it.

Scattered Quotes

My diaries are full of such missed opportunities, but the stock market is merciful – it always gives the nincopoop a second chance.

So much wisdom in one sentence. It’s a great idea to keep an investing diary. Jot down all your notes in it and be sure to write why you buy and sell companies. Over time it will become a great resource and will protect you from the enemy of continuous improvement, self deception. Don’t sweat your missed opportunities, there will be many more.

Flexibility was the key [to Magellan’s success]. There were always undervalued companies to be found somewhere.

By abandoning these great companies for lesser issues, I became a victim of the all-too-common practice of “pulling out the flowers and watering the weeds”

This is one of the keys to successful investing: focus on companies, not on the stocks.

Bargains are the holy grail of the true stockpicker. the fact that 10-30 percent of our net worth is lost in a market sell-off is of little consequence. We see the latest correction not as a disaster but as an opportunity to acquire more shares at low prices. This is how great fortunes are made over time.

The alert shopper has a chance to get the message about retailers earlier than Wall Street does, and to make back all the money he or she ever spends on the merchandise – by buying undervalued stocks.

It was huge gains in a few positions that led to Magellan’s superior results.

In stocks as in romance, ease of divorce is not a sound basis for commitment. If you’ve chosen widely to begin with, you won;t want a divorce. And if you haven’t you;re in a mess no matter what.

There were hundreds of losers in Magellan’s portfolio… Fortunately, they weren’t my biggest positions. This is an important aspect of portfolio management – containing your losses.

There’s no shame in losing money on a stock. Everybody does it. What is shameful is to hold on to a stock, or , worse, to buy more of it, when the fundamentals are deteriorating.

Since bonds come before stocks in the lineup of claimants on the company’s assets, you can be sure that when bonds sell for next to nothing, the stock will be worth even less… before you invest in a low-priced stock in a shaky company, look at what’s been happening to the price of the bonds.

Stockpicking is both an art and a science, but too much of either is a dangerous thing.

The smallest investor can follow the Rule of Five and limit the portfolio to five issues. If just one of those is a 10-bagger and the other four combined go nowhere, you’ve still tripled your money.

That last quotes succinctly conveys what I tried to in this post, Gain required to Make you Whole.

Getting involved with a manageable number of companies and confining your buying ans selling to these is not a bad strategy. Once you’ve bought a stock, presumably you’ve learnt something about the industry and the companies place within it… The more common practice of buying, selling, and forgetting a long string of companies is not likely to succeed.

There are many common themes in the quotes; buy what you know, buy companies not stocks, and water the flowers to name a few. I hope you’ve enjoyed these Lynchisms and perhaps learnt or at least was reminded of something as well. Please take a minute to share your favourite Lynch quote(s).

If that is enough Lynch for one sitting then check out Peter Lynch’s 20 Golden Rules.

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  • Very timely article.

    I am pasting a direct quote from Mr ROE you know who:

    “Personally I believe one of my most important contributions to the principles of value investing is the idea of future valuations. Nobody was talking about them at the time I started mentioning 2011 and 2012 valuations and rates of growth. They are important because we want to buy businesses with bright prospects. And a company whose intrinsic value is rising “at a good clip” demonstrates those bright prospects.”

    I am on the side of James Montier and the follies of paying for growth. The quote also reminds me of David Einhorn’s admonition against having “evolving hypothesis”.

  • Mr ROE or is it Mr GARP. Next thing you know he’ll be claiming he invented growth at a reasonable price investing. We both know Graham formalised value investing and Buffett layered on growth. Lynch and scores of other more growth oriented investors have always focused on future valuations. Even the likes of little ol’ me have fused value with growth for many years now and focused on future value rather than current. There is nothing new or important about the idea of future valuations. But hey, you gotta give the guy credit for being one heck of a marketeer.

    Here’s a repost from a comment on aussiestockforums:
    I think when you are investing on fundamentals it is acceptable to trade without a price-based stop, but it is unacceptable to not have a event- / fundamental-based stop. E.g. IV falling 2 reports in a row might trigger that, as your growth assumptions are no longer valid.” skc

    skc, that is a critical point that most newbies and some experienced investors forget.

    As Peter Lynch said “There’s no shame in losing money on a stock. Everybody does it. What is shameful is to hold on to a stock, or , worse, to buy more of it, when the fundamentals are deteriorating.”

    While Warren Buffett and a score of other investors may be sure enough of their IV calculations to double down, most investors are delusional about their prowess in calculating IV. A falling share price should be a prompt to double down on your research to uncover the reason why.

  • A good point to make about Warren Buffet and the value investing pros.

    Seeing how a veteran does a loop in a plane does not mean a flying newbie can simply “copy” him to achieve the same outcome. What really matters is coping with unexpected problems “during” the loop, which is where the vet survives and newbies get killed.

    Investing is no different.

  • Very well said John, I wish I had you analogous prowess.

    Stretching your analogy further, I think the newbie pilot who encounters problems early on in the aerobatic career will be better equipped to handle problem in the future, while those pilots who have blue skies and no problems will be found wanting when problems do arise.

    I meet some young investors the other night and they all commented on losing a significant portion of their capital during 2008-09. I said they should count themselves lucky and consider it an inexpensive education, as losing 40% of $10k should help you avoid losing 40% of $1M. That is of course if they learned from their mistakes.

  • Dean,

    Way OT from this post, but do you have any thoughts on whether this is a long-term sustainable uptrend and what is driving it?

  • Update: Short answer, long term uptrend is now at risk, but may continue for a while longer. Trend driven my strength of Australian economy coupled with risk carry trade. Australian economic strength based on commodities, strong banking and continued “wealth” effect of housing boom.

    Mike, wonderful to hear from you even if it’s OT. You won’t recall but back in Nov 2008 I made my fledging steps into the FX market after trying to get some information at theLiquid Lounge. You were one of the people who responded to me. If you look at that time on this USD:AUD chart you’ll see the technical perspective of why I fundamentally thought long AUD was a great idea. For me it was only a hedge and thus portfolio wise I have made no gains, but what a sensational opportunity it was for y’all. I said in that thread “I have never been concerned about hedging our US equities before as over the very long run see Fx as unimportant to our US based returns. However, I now see a freight train coming and wish to step off the Fx tracks for a while.
    Thesis is the sudden surge in the USD is not based on fundamentals, but on repatriation of funds causing imbalance in the Fx market
    .” None of that helps you now, but I wanted to make sure you understand my philosophy. I like to make market calls when the long term stars align with a very high probability. Making a call on AUD based on a breakout is not within my skill set or interest.

    Stick with me, I’m getting to an answer, I hope. AUD is in a long term uptrend, but my view is that the downside risks to AUD currently equal the upside. What has been driving the trend is commodities, a strong banking sector and overall the risk trade. Australia side stepped the GFC, thanks to both the strength in our banking sector due to strong regulatory framework set up due to a banking crisis in the 90’s and the mining sector’s strength. The Australian housing market is ludicrously overpriced and most pundits are still saying housing always goes up and demand is so strong that it will continue to do so. Does that sound familiar? I think the housing market is at a inflection point and will either provide no returns or losses over the next five years. Australia still has negative gearing and a lot of houses are owned by boomers who are likely to sell and perhaps for the first time create a property crash in Australia, historically the residential RE market here has simply flattened for 5-7 years after becoming this overbought. At best deleveraging is likely and banks will find it tough going at worst we’re in a deep pile of pooh. Then we come to commodities. Once again most people these think that commodities only go up. There is so much supply coming on line that within a few years prices are sure to head lower. In the meantime all it takes is a small Asian deceleration to crush prices.

    Then there are risks that I haven’t even thought about. Then perhaps most importantly AUD is the risk carry trade dejour. That is sure to end at some stage and the rush for the exits will be fast. The crisis doesn’t need to be Australian, any crisis that makes speculators risk adverse will see AUD fall.

    Very long term Australia is in a strong position. We are chock full of minerals, energy and could also dramatically increase our ag sector. The Australian stock market is the best long term performer in the world. We have a great superannuation system which will fund growing retirements, eventually. Bugger, my daughter has been in my ear this whole reply and I gotta go now, though I’ve got the sense that I wrote a lot without saying much.

    Short term I think the risk/reward is in balance, medium term I think a correction will come, very long term Australia and AUD look good but really if only bought from lower level. Here is a bearish perspective from a friend of mine . Feel free to ask more and I’ll try to be more succinct next time 😉

  • MIke
    In case you check back here is a bullish view on the AUD

    Apparently 28 years is a aberration and the current high AUD shows us the folly of our ways.

    Here’s one more idea that could topple this commodity based house of cards. When the AUD starts to fall, inflation will quickly rise as it has only been kept in check by the strength of the AUD. Inflation rate rise will bring interest rate rise which will make Australia’s over priced real estate suddenly un-affordable (as if it is affordable just because rates aren’t currently high), -> mass exodus from RE, massive popping of wealth bubble all the while AUD will continue falling.

    On the upside, if a strong AUD is here to stay at least I can afford a lot more skiing in the US.

  • “When the AUD starts to fall, inflation will quickly rise as it has only been kept in check by the strength of the AUD”

    G’day Dean, I completely agree with your comment above. It would interesting to try and strip out the deflationary impact of the strong AUD from the actual inflation rate, to try and get a feel for just how much we owe the AUD for keeping inflation in Australia below 3%. I would hazard a guess that the answer would be a lot.

    Just an example to think about, take the price of petrol. At $1.50 per litre (depending where you live) when each AUD is worth $1.02, what would the petrol price be if the AUD fell to say $0.85? Maybe $1.75 p/litre? $2.00? Whatever, it would be very ugly for your average Australian who is also juggling rising mortgage bills and a rising cost of living.

  • Dean,

    Thanks a ton for the detailed responses! Much appreciated, especially the links for further reading.

    FWIW, took a short-term technical trading position in my trading account. Stop out with 2 daily closes below 102 on FXA.

    Longer-term, I’ve been contemplating the idea of adding currencies to the concept of diversified asset allocation which I currently just include stocks, commodities, and REITs. My thought is that “dollar exposure” is going to become increasingly important to U.S. based investors in the coming years. I actually expect the long-term structural downtrend in the USD from 2001 to present to accelerate in the next 5-10 years, so the idea of devoting 5-10% of overall risk asset exposure strictly to currencies and then picking a few I think are the best positioned long-term is something that I think could make sense for a U.S. based investor.

  • “I think when you are investing on fundamentals it is acceptable to trade without a price-based stop, but it is unacceptable to not have a event- / fundamental-based stop. E.g. IV falling 2 reports in a row might trigger that, as your growth assumptions are no longer valid.” skc

    skc, that is a critical point that most newbies and some experienced investors forget.

    Actually, I think many experienced investors. Obviously, someone who incorporates TA into analysis will often or always have some sort of price-based stop. My sense is many fundamental investors default to the Bill Miller school of thought which is “they know they are wrong when the stock goes to zero”. Every price drop due to whatever reason is simply another opportunity to double down, triple down, quadruple down on a stock that is even more undervalued regardless of the reason of the price drop. Look how many presumably smart guys got burned on financial stocks during the 07-09 decline. Did they really understand the value on the balance sheet?
    I think it is critical to always revisit and reassess your thesis and ask on an ongoing basis “am I right” or is the market right?

  • Good discussion. David Einhorn has some good advice on this area namely:

    1. “We start by asking why a security is likely to be misvalued by a market…In order to invest, we need to understand why the opportunity exists and [why we] believe we have a sizable analytical edge over the person on the other side of the trade.”

    2. “We avoid “evolving hypotheses.” If our investment rationale proves false, we exit the position rahter than create a new justification to hold.”

  • Every price drop due to whatever reason is simply another opportunity to double down, triple down, quadruple down on a stock that is even more undervalued regardless of the reason of the price drop.
    But if it was good value at $20 it has to be fantastic value at $15. Surely the margin of safety is even wider and it’s now time to back up the truck.

    Just stirring Mike, trying to parody what many investors actually think. Rather than as I think you suggest they should. “I though it was great value at $20 and I had a wide margin of safety, but the market thinks other wise, so what did I miss.” I’ll go further and say too many investors focus on valuation and give it too much weight in their decisions. I prefer to think has the story improved, is my thesis playing out. I still struggle to completely ditch companies when my answer is no, but at least I’ve got to the point where, like Penrice Soda, I take half in and certainly do not add.

    More to add, but gotta rush. Thanks for taking the time to comment, I appreciate it. D

  • Quick update. Sold my FXA position today at 108 and change. In at 102 so it worked out well.

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