Peter Lynch is undoubtedly one of the greatest investors who’s ever lived, not only for the stellar returns he produced but also for his passion to educate others about investing.
While at the helm of Fidelity’s Magellan mutual fund, he generated a 29.2% annual return from 1977 to 1990. This record is unheard of anywhere else on Wall Street. So let’s dive into this incredibly interesting man’s life and explore what led him to become such a great investor.
Peter Lynch was born in 1951 in the state of Massachusetts. He attended the local Boston College as an undergraduate, which is where he discovered his interest for the markets. As a sophomore, he used his savings to buy 100 shares of Flying Tiger Airlines at $8 per share. Soon enough, the stock rose to $80 per share, making him 10 times his money. He later attended the Wharton School to obtain an MBA.
Lynch began his career at Fidelity Investments, one of the largest mutual funds in the United States. Lynch joined Fidelity Investments as an analyst but quickly rose through the ranks to become head of the then unknown Magellan fund, which at the time had $18 million in assets. By the time Peter was done with the fund in 1990, his legendary record had attracted over $14 billion in assets with roughly 1,000 stocks in the fund’s portfolio. As outlined in his book, One up on wall street, Lynch has a very specific way of analyzing stocks.
You could say that he blends both value investing and growth investing into one, looking for situations in which a company can significantly outperform the market. Though he does not concern himself too much with the price of a stock, he does place a big emphasis on companies that can consistently grow. During his time at Fidellity, he was able to pick over 100 stocks that multiplied his investment by 10. Since Peter Lynch could be considered part value investor part growth investor, all the features we looked at for Buffett and Fisher apply to him. Nevertheless, Lynch does have a unique twist in the way he looks at companies. One of the key tenets of Lynch’s philosophy is investing in what you know.
This is something we heard Warren Buffett say countless times, but I can’t stress this enough. If you don’t understand what a company is doing before investing in it, then it’s like betting on the slowest horse in the race and hoping that the other horses ate bad hay.
There’s little point investing in Apple if all you know about it is that it produces phones and computers and you don’t understand what impact of something like Moore’s law will have on the cost of production of storage and semiconductors.
These are obviously complicated questions, but crucial to answer if you really want to engage with the company and most importantly be able to actually understand its financial performance. So, you might ask, what are other possible investment areas if I don’t truly understand what Apple does? Simple. Pick something you know, anything.
It can be a supermarket chain or a multinational hotel company. As long as you understand it, you’ll not only be interested in what the company is doing, but you’ll read through the reports it releases with ease. Obviously, it doesn’t mean that you understand it that the business is a good investment. But at least it will help you comprehend the financials better. At the same time, Lynch provides another important piece of advice.
He believes that everyone has knowledge that they can use to profit in the stock market. And that that knowledge is all around us. For example, if you’re a construction worker and you see that you are beginning to use a different type of cement because of its superior quality, you should look into the company that produces that cement, especially if this a trend you see at all construction sites. Or if you’re a student and you realize that all your friends are suddenly eating at Subway instead of McDonalds, that’s certainly worth looking into.
People often do not realize this, but they are typically ground-zero when it comes to new products and new offerings. You just have to keep your eyes wide open to new trends that could be sweeping the market. Jim Cramer, who is the star of the financial show, Mad Money, once talked about how his daughter introduced him to the fast food business Chipotle before it became big since her friends all ate there.
This is the type of information that can help you spot winners before they become giants. After you’ve found a company you believe can perform well into the future, it’s necessary to look at its financial results in closer detail, especially the income statement and balance sheet. Using the Lynch methodology, you should always focus on growth expectations for a stock. You can do so using the PEG ratio, which looks at valuation in relation to the growth in earnings.
Ideally, a stock will have a PEG of under 1, which indicates the stock might be undervalued. Another metric to consider is the percentage of assets in cash. Strong cash flow and conservative management of assets gives the company the opportunity to thrive regardless of the state of the market. It is at the same time positive to have low debt in relation to equity.
These are all measurements you can find on a company’s financial filings with the Securities and Exchange Commission, all of which is available online, and these are things we will talk about later too. Once you have determined whether the company is set to outperform over the coming years, you need to create a story for yourself. This is something that Lynch did before making an investment.
Essentially you want to prepare a 5 minute speech that you rehearse in your head whereby you talk about the company itself, why it is a good investment, what it needs to do to continue to perform well and where you hope it is heading. You might want to take note of the story you end up building and check up on the company every once in a while to verify it sticks to the narrative.
In general however, these are the six types of stories that can apply to different companies: The first are slow growers, which are companies that are expected to grow slightly faster than the gross domestic product, which is typically around 2%. These companies initially started as fast growers but slowed down over time. For example large car companies like Ford or General Motors were fast growers but as they became bigger, their growth slowed. Given their huge size, these companies typically pay large dividends.
Stalwarts are companies like Coke, which see 10-12% annual growth in earnings. so even though they grow faster than slow growers, they are not as large. Fast growers are small aggressive new companies that grow at 20-25% a year. Peter Lynch says that you need to find fast growers that have robust balance sheets with lots of assets and that make large profits. So Cyclicals go up and down depending on the economic condition.
Automobile manufacturers and airlines are good examples of these. If the economy is thriving, people spend more money on travel and buying new cars. This differs from stalwarts like coke. If you make less money, one of the first expenses you’ll cut is travel and leisure. Turnarounds on the other hand are companies that have recently performed poorly but are starting to pick up. Although they are hard to find, they can present great buying opportunities. Finally, Asset plays are businesses that are valuable mainly because of all the assets they own.
The most typical example of these are real estate companies. You need to keep in mind that a proper investment portfolio should try to mix things up and have a bit of each. Alright now lets take a look at some of Peter’s most famous investments. The first has to be Ford. Ford is undeniably one of the most renowned companies in the world, and certainly one of the best run. Lynch invested in Ford when the stock traded at $1 and saw it surge to over $14 during his lifetime.
That’s a 1300% return! Another famous investment of his was Philip Morris, which at the time was the largest tobacco company in the United States. Following studies that showed smoking can kill, Philip Morris began diversifying its holdings and eventually became a major company in the food business.
This led to its stock growing at an annualized 18% between 1970 and 2000. In the end, what’s interesting about Peter Lynch’s investment philosophy is really how it combines different strategies and adds its own twist.
Lynch wants investors to really understand what they invest in, which is one of the reasons why he encourages people to invest in what they know. At the same time, he seeks to empower prospective shareholders by enticing them to keep their eyes open for possible investment opportunities that might be anywhere around them.
You can’t forget, a share is a piece of a company afterall so buying into businesses when they really take off can present tremendous opportunities as was proven by Lynch himself.