One Up On Wall Street: How To Use What You Already Know To Make Money In

by Peter Lynch

rule number one, in my book, is: Stop listening to professionals! Twenty years in this business convinces me that any normal person using the customary three percent of the brain can pick stocks just as well, if not better, than the average Wall Street expert.

In Wall Street parlance a “tenbagger” is a stock in which you’ve made ten times your money.

The more right you are about any one stock, the more wrong you can be on all the others and still triumph as an investor.

I talk to hundreds of companies a year and spend hour after hour in heady powwows with CEOs, financial analysts, and my colleagues in the mutual-fund business, but I stumble onto the big winners in extracurricular situations, the same way you could:

the nice thing about investing in familiar companies such as L’eggs or Dunkin’ Donuts is that when you try on the stockings or sip the coffee, you’re already doing the kind of fundamental analysis that they pay Wall Street analysts to do. Visiting stores and testing products is one of the critical elements of the analyst’s job.

During a lifetime of buying cars or cameras, you develop a sense of what’s good and what’s bad, what sells and what doesn’t. If it’s not cars you know something about, you know something about something else, and the most important part is, you know it before Wall Street knows it. Why wait for the Merrill Lynch restaurant expert to recommend Dunkin’ Donuts when you’ve already seen eight new franchises opening up in your area? The Merrill Lynch restaurant analyst isn’t going to notice Dunkin’ Donuts (for reasons I’ll soon explain) until the stock has quintupled from $2 to $10, and you noticed it when the stock was at $2.

Among amateur investors, for some reason it’s not considered sophisticated practice to equate driving around town eating donuts with the initial phase of an investigation into equities. People seem more comfortable investing in something about which they are entirely ignorant. There seems to be an unwritten rule on Wall Street: If you don’t understand it, then put your life savings into it. Shun the enterprise around the corner, which can at least be observed, and seek out the one that manufactures an incomprehensible product.

Gig my gigahertz and whetstone my megaflop, if you couldn’t tell if that was a racehorse or a memory chip you should stay away from it, even though your broker will be calling to recommend it as the opportunity of the decade to make countless nanobucks.

Throughout this book we’re going to be faced with the complication that occurs when companies split their shares—two-for-one, three-for-one, etc. If you invest $1,000 in 100 shares of Company X, a $10 stock, and there’s a two-for-one split, then suddenly you own 200 shares of a $5 stock. Two years later, let’s say, the stock price has risen to $10 a share and you’ve doubled your money. Yet to a person who didn’t know about the split, it would appear as if you’d made nothing—the stock you bought for $10 is still selling for $10.

Companies generally prefer not to have their share prices too high in absolute dollar terms, which is one reason why stock splits are declared.

Before you think about buying stocks, you ought to have made some basic decisions about the market, about how much you trust corporate America, about whether you need to invest in stocks and what you expect to get out of them, about whether you are a short-or long-term investor, and about how you will react to sudden, unexpected, and severe drops in price. It’s best to define your objectives and clarify your attitudes (do I really think stocks are riskier than bonds?) beforehand, because if you are undecided and lack conviction, then you are a potential market victim, who abandons all hope and reason at the worst moment and sells out at a loss. It is personal preparation, as much as knowledge and research, that distinguishes the successful stockpicker from the chronic loser. Ultimately it is not the stock market nor even the companies themselves that determine an investor’s fate. It is the investor.

small investors tend to be pessimistic and optimistic at precisely the wrong times, so it’s self-defeating to try to invest in good markets and get out of bad ones.

Investing in stocks is an art, not a science, and people who’ve been trained to rigidly quantify everything have a big disadvantage.

if a stock is down but the fundamentals are positive, it’s best to hold on and even better to buy more.)

In our business the indiscriminate selling of current losers is called “burying the evidence.”

Among the seasoned portfolio managers, burying the evidence is done so quickly and efficiently that I suspect it’s already become a survival mechanism, and it will probably be inbred so that future generations can do it without hesitation, the way that ostriches have learned to stick their heads in the sand.

The bigger the equity fund, the harder it gets for it to outperform the competition. Expecting a $9-billion fund to compete successfully against an $800-million fund is the same as expecting Larry Bird to star in basketball games with a five-pound weight strapped to his waist.

Big funds have the same built-in handicaps as big anythings—the bigger it is, the more energy it takes to move it.

You don’t have to invest like an institution. If you invest like an institution, you’re doomed to perform like one, which in many cases isn’t very well.

There’s nobody to chide you for buying back a stock at $19 that you earlier sold at $11—which may be a perfectly sensible move. Professionals could never buy back a stock at $19 that they sold at $11. They’d have their Quotrons confiscated for doing that.

Most important, you can find terrific opportunities in the neighborhood or at the workplace, months or even years before the news has reached the analysts and the fund managers they advise.

Since there’s very little in the corporate bond business that isn’t callable, you’re advised to buy Treasuries if you hope to profit from a fall in interest rates.)

Historically, investing in stocks is undeniably more profitable than investing in debt.

In fact, since 1927, common stocks have recorded gains of 9.8 percent a year on average, as compared to 5 percent for corporate bonds, 4.4 percent for government bonds, and 3.4 percent for Treasury bills.

In spite of crashes, depressions, wars, recessions, ten different presidential administrations, and numerous changes in skirt lengths, stocks in general have paid off fifteen times as well as corporate bonds, and well over thirty times better than Treasury bills!

fortunes change, there’s no assurance that major companies won’t become minor, and there’s no such thing as a can’t-miss blue chip.

Buy the right stocks at the wrong price at the wrong time and you’ll suffer great losses.

with the possible exception of the very short-term bonds and bond funds, bonds can be risky, too. Here, rising interest rates will force you to accept one of two unpleasant choices: suffer with the low yield until the bonds mature, or sell the bonds at a substantial discount to face value.

Yes, I know bonds pay off in 99.9 percent of the cases, but there are other ways to lose money on bonds besides a default. Try holding on to a 30-year bond with a 6 percent coupon during a period of raging inflation, and see what happens to the value of the bond.

Historically, stocks are embraced as investments or dismissed as gambles in routine and circular fashion, and usually at the wrong times. Stocks are most likely to be accepted as prudent at the moment they’re not.

For years, stocks in large companies were considered “investments” and stocks in small companies “speculations,” but lately small stocks have become investments and the speculating is done in futures and options. We’re forever redrawing this line.

to the rash and impetuous stock player, my advice is: Forget Wall Street and take your mad money to Hialeah, Monte Carlo, Saratoga, Nassau, Santa Anita, or Baden-Baden.

By asking some basic questions about companies, you can learn which are likely to grow and prosper, which are unlikely to grow and prosper, and which are entirely mysterious.

You can never be certain what will happen, but each new occurrence—a jump in earnings, the sale of an unprofitable subsidiary, the expansion into new markets—is like turning up another card. As long as the cards suggest favorable odds of success, you stay in the hand.

Consistent winners raise their bet as their position strengthens, and they exit the game when the odds are against them, while consistent losers hang on to the bitter end of every expensive pot, hoping for miracles and enjoying the thrill of defeat.

In stud poker and on Wall Street, miracles happen just often enough to keep the losers losing.

If seven out of ten of my stocks perform as expected, then I’m delighted. If six out of ten of my stocks perform as expected, then I’m thankful. Six out of ten is all it takes to produce an enviable record on Wall Street.

With improper play (buying a stock that’s overpriced) even the purchase of Bristol-Myers or Heinz can result in huge losses and wasted opportunities, as I’ve said.

It happens to people who imagine that betting with blue chips relieves them of the need to pay attention, so they lose half their money in quick fashion and may not recoup it for another eight years.

Before you buy a share of anything, there are three personal issues that ought to be addressed: (1) Do I own a house? (2) Do I need the money? and (3) Do I have the personal qualities that will bring me success in stocks?

(1) DO I OWN A HOUSE?

in 99 cases out of 100, a house will be a money-maker.

The old Wall Street adage “Never invest in anything that eats or needs repairs” may apply to racehorses, but it’s malarkey when it comes to houses.

No wonder people make money in the real estate market and lose money in the stock market. They spend months choosing their houses, and minutes choosing their stocks. In fact, they spend more time shopping for a good microwave oven than shopping for a good investment.

(2) DO I NEED THE MONEY?

Absent a lot of surprises, stocks are relatively predictable over ten to twenty years. As to whether they’re going to be higher or lower in two or three years, you might as well flip a coin to decide. Blue chips can fall down and stay down over a three-year period or even a five-year period, so if the market hits a banana peel, then Dexter’s going to night school.

Only invest what you could afford to lose without that loss having any effect on your daily life in the foreseeable future.

(3) DO I HAVE THE PERSONAL QUALITIES IT TAKES TO SUCCEED?

It seems to me the list of qualities ought to include patience, self-reliance, common sense, a tolerance for pain, open-mindedness, detachment, persistence, humility, flexibility, a willingness to do independent research, an equal willingnes...

The true geniuses, it seems to me, get too enamored of theoretical cogitations and are forever betrayed by the actual behavior of stocks, which is more simple-minded than they can imagine.