Peter Lynch is a legendary investor who ran the Magellan Fund at Fidelity between 1977 and 1990. Over that time, he beat the market in 11 out of 13 years, averaging an astonishing 29% annual return. He started with $18 million in assets and eventually grew it to $14 billion. Lynch also helped teach generations of investors with his books "Beating the Street" and “One up on Wall Street."
In a rare interview in 1993 with Charlie Rose, Lynch talked about his investment strategy and revealed key insights which are still extremely relevant today.
What moves stock prices?
A stock's price movement can be governed by a variety of factors. In the short term, it is generally governed by supply/demand or fear and greed, which is difficult to estimate as humans tend to be irrational. However, in the long term, the share price of a company generally rises with its earnings or profitability.
This may seem like a simple concept but it is one which is often overlooked. Lynch explains it simply with a great example. He points out that medical company Johnson & Johnson (JNJ, Financial) generated “higher earnings than four years ago,” therefore the stock price was higher, whearas Xerox (XRX, Financial) generated earnings “lower than four years ago” and thus its stock price was lower.
Lynch states he was only “right six out of 10 times,” but when right it could be a double or a triple gain, which offset losses. Even if you're right three out 10 times, as long as the stock triples on the upside and your downside risks are low, you can still boost your portfolio.
Know what you own
Lynch believes the number one rule in investing is to “know what you own." That way if a stock declines and you understand the business, you are comfortable in knowing the reasons for the decline. “Some of my stocks have gone from $18 to $8 and then to $40," Lynch said.
The key is to only add if the “fundamentals are the same or getting better." Not every stock you invest into will bounce back from a loss.
“If you want to invest, at least do the same type of research you do if buying a refrigerator, Lynch said.
Lynch also suggests starting a “paper portfolio” when first starting out and writing for each stock what you paid and five reasons why. Then, you can track this over a number of years to see if you did well or not.
When to buy a stock
Many companies have what is called a corporate lifecycle, in that they start as fast growing startups before becoming a “scale up” and then a mature company, usually before decline. When to invest into a company is tricky, but Lynch suggests getting in when a concept is proven but there is still growth potential.
Using a baseball analogy, Lynch explains “you want to get in, during the first second, third innings." For example, if a company already has stores in every state, then there isn’t much runway left for growth. Lynch uses the example of Walmart (WMT, Financial) to explain this strategy:
“You could have bought Walmart 10 years after they went public and then still made 50 fold... Ten years after they went public they were only in 18% of the United States."
The average person can be a great investor
Lynch has inspired millions of people to invest into the markets as he believes our own unique experiences can give us insight. Lynch points out that often people will invest into stocks in a really complex industry because they have an exciting name or got a tip from someone. Instead, Lynch suggests focusing on stocks which you understand and see value in their product. One of is favorite phrases is “if you like the product, you may like the stock."
For example, he suggests the average person would have seen crowded stores such as The Gap (GPS, Financial) and Dunkin Donuts (DNKN, Financial) before the guys on Wall Street, which gives them an edge. The important thing is to focus on what you understand. “If you're in the steel industry, look at steel stocks, rather than a crazy biotech," said Lynch.
Three C’s to watch out for
Lynch says there are three C’s you should watch out for with investing: complacency, concern and capitulation.
Complacency is when everything is going right with a company and you “forget to check the facts.” This could be new competitors are coming along, the company is “starting to mature” or just losing its edge. Lynch suggests you should always be checking with customers, suppliers and competitors. This all helps to avoid a capitulation scenario, which we have seen recently with many great stocks from Netflix (NFLX, Financial) to Meta (META, Financial).
How to identify great managers
Lynch is famous for traveling all over the world and meeting great managers. The legendary investor Phil Fisher calls this the Scuttlebutt method. All great managers are “problem solvers.” The definition of management is “getting things done through others.” You have to inspire, motivate and encourage others. You have to understand what they want, work with them and set goals. Great leaders are persistent but not stubborn. Great managers also listen to those around them.
This reminds me of a quote by Simon Sinek, that “great leaders speak last."
A question Lynch likes to ask managers is, “Who is your best competitor?” He also likes to ask, “Which competitors worry you?" This actually helps to identify better companies with unique selling propositions.
Communication as a key to success
The ability to listen is a powerful skill. At the end of asking questions to managers, Lynch suggests asking, "Is there something I’ve forgotten?" or “What question have I missed here?” or even “A year ago when you thought things were going to be great, how did it turn out… what have been surprises for you?”
Always be nice and build rapport. Do your homework on a company before meeting the key people. You can even listen to management's “tone of voice” - does it show confidence or worry?
Should you short stocks?
When shorting stocks, you can only make double your money. But when you go long on a stock, it can go up infinitely. There are also many dangers with shorting stocks. Due to these factors, Lynch isn't fond of shorting stocks.
Will the stock market go up?
The stock market growth long term is driven by corporate profits, which have historically trended upwards. “Over the next 10, 20 and 30 years, I think the stock market is the place to be," Lynch said.
From Lynch's optimism in 1993 to today, the S&P 500 has risen by nearly 800%. This is despite the tech bubble crash of the late 90’s, the financial crisis of 2008 and even the Covid crash of 2020.
Interestingly, Lynch also states “over the next one to two years” he has “no clue” if stocks will go up. This goes back to my earlier point that predicting the stock market over short periods is extremely difficult.
Final thoughts
Peter Lynch is a legendary investor and his words of wisdom back in 1993 and still extremely relevant today. He believes investing into simple businesses you understand is a solid key to success. Investing is an ever changing landscape, but fundamental principles help to improve your odds of success in the long term.
