Beating the Street

by Peter Lynch

There were always undervalued companies to be found somewhere.

I put 15 percent of the assets into utilities. I owned Boeing and Todd Shipyards right along with Pic ’N’ Save and Service Corporation International,

I was attracted to fast-food restaurants because they were so easy to understand. A restaurant chain that succeeded in one region had an excellent chance of duplicating its success in another.

Fortunately, I never invested much money in things I didn’t understand,

I realize that many stocks that I held for a few months I should have held a lot longer. This wouldn’t have been unconditional loyalty, it would have been sticking to companies that were getting more and more attractive.

Some investors, the rumor goes, own a share of Buffett’s Berkshire Hathaway company (these cost $11,000 apiece) simply to get on the mailing list for Buffett’s reports.

I’d spend an hour or so with the guy from Sears and find out about carpet sales.

Details from peter lynch

My personal rule was that once a month I ought to have at least one conversation with a representative of each major industry group, just in case business was starting to turn around or there were other new developments that Wall Street had overlooked. This was a very effective early-warning system.

I always ended these discussions by asking: which of your competitors do you respect the most? When a CEO of one company admits that a rival company is doing as good a job or better, it’s a powerful endorsement. The upshot was that I often went out and bought the other guy’s stock.

I didn’t know a thing about insurance until I met with executives at Aetna, Travelers, and Connecticut General in Hartford. In a couple of days they gave me a crash course in the business. I never had the same sort of edge that an insurance professional has, but I learned to identify the factors that make the earnings rise and fall. Then I could ask the right questions.

I didn’t discover this by sitting at my desk and imagining what would happen when interest rates declined. I discovered it at a regional investment conference in Atlanta organized by Robinson-Humphrey.

my biggest winners in the bank group have been the regionals, such as the three shown on pages 96–98. I always look for banks that have a strong local deposit base, and are efficient and careful commercial lenders.

Small is not only beautiful, it also can be lucrative.

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

After every contact I made, on the phone or in person, I’d scribble a notation in a loose-leaf binder—the name of the company and the current stock price, followed by a one- or two-line summary of the story I’d just heard. Every stockpicker, I think, could benefit from keeping such a notebook of stories. Without one, it’s easy to forget why you bought something in the first place.

90 seconds is plenty of time to tell the story of a stock. If you’re prepared to invest in a company, then you ought to be able to explain why in simple language that a fifth grader could understand, and quickly enough so the fifth grader won’t get bored.

90 sec explaintion and a 10 years hold

With a 25 percent return, your money doubles in less than 3 years:

A computer company can lose half its value overnight when a rival unveils a better product, but a chain of donut franchises in New England is not going to lose business when somebody opens a superior donut franchise in Ohio. It may take a decade for the competitor to arrive, and investors can see it coming.

a portfolio manager who cares about job security tends to gravitate toward acceptable holdings such as IBM, and to avoid offbeat enterprises like Seven Oaks,

“When the market heads lower, I sell the conservative stocks and add to the others. When the market picks up, I sell some of the winners from the growth stocks and cyclical stocks and add to the conservative stocks.”

By mid-1983 there were 450 stocks in the Magellan portfolio, and by fall, the number had doubled to 900. This meant I had to be prepared to tell 900 different stories to my colleagues in 90 seconds or less.

The investment seminar was the greatest laborsaving device for fund managers ever invented.

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

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.

Never bet on a comeback while they’re playing “Taps.”

Here’s a tip from experience: before you invest in a low-priced stock in a shaky company, look at what’s been happening to the price of the bonds.

The company bonds

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

If you could tell the future from a balance sheet, then mathematicians and accountants would be the richest people in the world by now.

One of their favorite excuses is that “a stock is like a woman—you can never figure one out.”

My stockpicking method, which involves elements of art and science plus legwork, hasn’t changed in 20 years.

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.

Buy shares when the stock price is at or below the earnings line, and not when the price line diverges into the danger zone, way above the earnings line.

You could make a nice living buying stocks from the low list in November and December during the tax-selling period and then holding them through January, when the prices always seem to rebound. This January effect, as it’s called, is especially powerful with smaller companies,

Just because a stock is cheaper than before is no reason to buy it, and just because it’s more expensive is no reason to sell.

Many of the biggest gainers of all time come from the places that millions of consumers visit all the time. An investment of $10,000 made in 1986 in each of four popular retail enterprises—Home Depot, the Limited, the Gap, and Wal-Mart Stores—and held for five years was worth more than $500,000 at the end of 1991.

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

Employees at the malls have an insiders’ edge, since they see what’s going on every day, plus they get the word from their colleagues as to which stores are thriving and which are not. The managers of malls have the greatest advantage of all—access to the monthly sales figures that are used to compute the rents.

The Lynch family has no relatives who are mall operators, otherwise I’d be inviting them over for dinner three or four times a week. But we do have shoppers, which is the next best thing. My wife, Carolyn, doesn’t do as much research

As much as we like to think our children are unique, they are also part of an international tribe of shoppers with the same taste in caps, T-shirts, socks, and prewrinkled jeans,

The best part of the story was that the expansion was in its early stages and the idea seemed to have worldwide appeal.

the balance sheet was strong, and the company was growing at 20-30 percent a year. What was wrong with this story? The p/e ratio of 42, based on the S&P estimate of 1992 earnings. Any growth stock that sells for 40 times its earnings for the upcoming year is dangerously high-priced, and in most cases extravagant. As a rule of thumb, a stock should sell at or below its growth rate—that is, the rate at which it increases its earnings every year. Even the fastest-growing companies can rarely achieve more than a 25 percent growth rate, and a 40 percent growth rate is a rarity.

it came down to a choice between owning Coca-Cola, a 15 percent grower selling at 30 times earnings, and the Body Shop, a 30 percent grower selling at 40 times earnings, I preferred the latter. A company with a high p/e that’s growing at a fast rate will eventually outperform one with a lower p/e that’s growing at a slower rate.

The best way to handle a situation in which you love the company but not the current price is to make a small commitment and then increase it in the next sell-off.

In a retail company or a restaurant chain, the growth that propels earnings and the stock price comes mainly from expansion. As long as the same-store sales are on the increase (these numbers are shown in annual and quarterly reports), the company is not crippled by excessive debt, and it is following its expansion plans as described to shareholders in its reports, it usually pays to stick with the stock.

You’ve got to go into places where other investors and especially fund managers fear to tread, or, more to the point, to invest.

A technique that works repeatedly is to wait until the prevailing opinion about a certain industry is that things have gone from bad to worse, and then buy shares in the strongest companies in the group.

I figured it might be undervalued, especially in light of a probable recovery in housing. I opened up my Pier 1 file to refresh my memory.

He brought up several favorable factors: (1) the company had made money in 1991 in a very difficult environment; (2) it was expanding at a rate of 25–40 new stores a year; and (3) with only 500 stores in the U.S., it was nowhere close to saturating the market.

Whenever I’m evaluating a retail enterprise, in addition to the factors we’ve already discussed I always try to look at inventories. When inventories increase beyond normal levels, it is a warning sign that management may be trying to cover up the problem of poor sales.

It was cutting costs, improving its profit margins, and making money in a bad year; it had raised its dividend five years in a row,