Stocks, Forex and Other Money Matters

Peter Lynch essentially created the Magellan Fund. After he took charge in 1977, it became the largest mutual fund in history, which it still was twenty years later. It had over a million shareholders, and during his tenure paid Fidelity, its managers, some US$60 million a year in management fees and several hundred million in sales commissions. (The 3% sales commission goes straight into the pocket of the owners of the management company; there are no salesmen.)

Lynch attended Boston College on a golf caddie scholarship, and happened to caddie for Fidelity Investments president D. George Sullivan, which helped him land part-time summer work with the firm. He started full-time with Fidelity in 1971 and by 1974 became director of research. In analyst meetings, Lynch would urge his colleagues not to tear down each other’s ideas, but rather to explain why their own ideas are good ones.

Lynch says that he has an edge because a lot of people he competes with are looking for reasons NOT to buy: The company is unionized; GE will come out with a competitive product that will kill them; or whatever. There is a whole list of biases that scare most investors away from studying the situation at all, so you miss a lot. To make money, Lynch says, you must find something that nobody else knows, or do something that others won’t do because they have rigid mind-sets. He also points out that it’s all right to make mistakes as the price of catching huge winners: The stock that doubles from 10 to 20 pays twice over for the one that falls in half from 10 to 5.

Lynch’s cardinal advantage over the legion of his competitors, besides his basic talent, is simply the enormous dedication he brings to the task. Lynch tries harder. In twenty years of marriage he took two proper vacations. A stockbroker who accompanies him on a trip mentioned that in a country where things barely get going at ten o’clock in the morning, Lynch insisted on starting to see companies at eight, and was quite grumpy that none could be found to talk to him at six! When at the end of the day the idea of dinner was raised, Lynch begged off, saying, ’I gotta read four annual reports by tomorrow.’ This broker said he had never seen anyone so well prepared for a company visit.

Lynch’s basic objective is to catch the turn in a company’s fortunes, which might be described as the time-efficient technique of deploying capital. Often, there is a one-to-twelve-month interval between a material change in a company and the corresponding movement in its stock. That’s what Lynch wants to capitalize on.

Lynch believes in an old trader’s rule: If you buy a stock because you hope something will happen, and it doesn’t happen, sell the stock. Wall Street has a sardonic expression for this idea: ’An investment is a speculation that didn’t work out.’ You had an idea, based on an expectation; you were wrong. So now you really have no reason to hold on to the stock and should sell it cleanly and quickly. Lynch says he often sells too soon. But you don’t get hurt by things that you don’t own that go up. It’s what you do own that kills you.

Of the stocks that I buy, says Lynch, three months later I am happy with less than a quarter of them. So if I like to look at ten stocks, it’s better for me to buy all ten, and then go on studying and researching. Perhaps I won’t like a number of them later on, but I can keep the ones that I do like, and increase those positions. And companies keep changing as you look: Competition may intensify; a problem plant may be sold off or closed; a competitive plant may burn down. So if you stay tuned, you can find that the fundamentals are changing.

Or even if they don’t change, the stock may go from 20 to 16. Perhaps I bought 10,000 at 20, and then I’ll buy 100,000 at 16. If I look at ten companies, I may find one company that is interesting. If I look at twenty companies then I may find two. If I look at forty, I may find four. If I look at a hundred, I may find ten. If other people saw as many companies as I do, I think that nine out of ten of them, when they heard the same story, would say, ’Wow,’ just the way I do, and be able to make the same buyin’ decision. You have to be a good listener in this business. And of course you may not be able to decide on the first visit. It may happen a year later or two years later.

Lynch thinks the worst traps is to buy exciting companies that do not have earnings. He can remember buying dozens of companies– where had the story come true– he would have made 1,000% on his money, and losing every time. And yet, and yet…! Wonderful new stories appear– ’the sizzle, not the steak,’ as he says– and again he will bite, and again he will lose.

The very best way to make money in a market is in a small growth company that has been profitable for a couple of years and simply goes on growing, says Lynch, who further observes that it is easier to make big percentage gains in stocks of small companies than in those of big ones. It is much harder for a stock in the Dow Jones Industrial Average to triple than it is for a stock in little NASDAQ companies. He is not strictly a value investor by any means, noting that if you get the facts right, you can be justified paying a high PE ratio for a rapidly growing company.

Lynch also discourages market timing. Starting in 1954, he has written, an investor sticking with the S&P for the following 40 years would have made an annual return on his investment of 11.4%. If he was out of stocks for the ten most profitable months, usually as the market bounced sharply from a bottom, the return fell to 8.3%. If he missed the 40 most profitable months, his return collapsed to 2.7%! Lynch is a fanatic about the stock market. Delight in his craft is Lynch’s secret to success!

Credits: Much of this article was extracted from Money Masters Of Our Time (John Train, 2000). Lynch has written two bestselling books, including One Up on Wall Street, since his retirement in 1991.

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