One of my favorite all time investors is Peter Lynch. As the manager of the Magellan Fund at Fidelity Investments between 1977 and 1990, Lynch averaged a 29.2% annual return, consistently more than doubling the S&P 500 market index and making it the best performing mutual fund in the world. During his tenure, assets under management increased from $18 million to $14 billion.
One of the best Lynch interviews can be found in the book, Investment Gurus: A Road Map to Wealth from the World’s Best Money Managers, written by Peter Tanous. In this interview Lynch discusses his investing strategy saying, investing is not about intelligence, its about keeping an open mind and doing a lot of hard work.
Here’s an excerpt from that interview:
Tanous: Peter, since you are arguably the most successful, as well as the most famous, fund manager of all time, and given the focus of this book, I want to zero in on process and methodology, especially on areas that I think will fascinate readers of this book. My first question relates to style. From my analysis, I’d say you have a growth bias, but you really can’t be pegged to one style, unlike so many of the others in this book. In fact, in Beating the Street, you said: “I never had an overall strategy. My stockpicking was entirely empirical.” That was some stockpicking! Apart from hanging around at malls, could you tell us a little bit about the selection process?
Lynch: I guess I was always upset by the fact that they called Magellan a growth fund. I think that is a mistake. If you pigeonhole somebody and all they can buy are the best available growth companies, what happens if all the growth companies are overpriced? You end up buying the least overpriced ones. If you can find growth companies at very low valuations and with great balance sheets and great futures, that’s where you invest. Only sometimes you find that these companies are terrific, but they are selling at 50 times earnings.
My premise has always been that there are good stocks everywhere. Some people say you can’t buy companies with unions, or you can’t buy companies in dying industries; for instance, who would ever buy a textile company? I mean, I didn’t buy it but a company called Unifi went up, I think, a hundred fold in the textile industry. I missed it.
But look at all the money I made with Chrysler and with Boeing. I also lost money with a few airlines and I made money with airlines. But you hear this concept that you can’t make money if you ever buy a company that has a union, because the union will kill it. These are prejudices and biases that prevent people from looking at a lot of different industries. I never had that. I think there are good and bad stocks everywhere.
Tanous: But in zeroing in on the process, one of the things that mystifies me is this: How much of your personal ability just can’t be defined? I mean, how much of it is simply the keen, even instinctive, judgment that you have, and maybe that a lot of other people don’t? Or is there some methodology that you hang your hat on that you, and maybe our readers, can turn to for process?
Lynch: I think that if you take my great stocks, and you ask a hundred people to visit them and spend a reasonable amount of time at it, 99 of them, assuming they had no prejudices and biases, would have bought those same stocks. I disagree with a part of your question. I don’t think that with great stocks you need a Cray super-computer or an advanced Sun microstation to figure out the math.
Take this example of a company I missed: Wal-Mart. You could have bought Wal-Mart ten years after it went public. Let’s say you’re a very cautious person. You wait. Now ten years after it went public, it was a twenty-year-old company. This was not a startup. So it’s now ten years after the public offering. You could have bought Wal-Mart and made 30 times your money. If you bought it the day it went public you would have made 500 times your money. But you could have made 30 times your money ten years after it went public.
The reason you could have done that is that ten years after it went public, it was only in 15% of the United States. And they hadn’t even saturated that 15%. So you could say to yourself, now what kind of intelligence does this take? You could say, this company has minimal costs, they’re efficient, everybody who competes with them says they’re great, the products are terrific, the service is terrific, the balance sheet is fine, and they’re self-funding. So you say to yourself, why can’t they go to 17% [saturation]? Why can’t they go to 21%? Let’s take a huge leap of faith: why can’t they go to 23%? All they did for the next two decades was roll it out. They didn’t change it. I only wish they had started out in Connecticut instead of in Arkansas. I bought Stop & Shop because I saw it here in New England. I also bought Dunkin’ Donuts because they were a local company.
Tanous: You’re touching on what I call the Great Peter Lynch Investment Theorem, which is to observe early business success as it occurs around you. I suppose it helps when the great companies happen to be in your own backyard and you see them every day. Of course, you’ve done well with other companies, too.
Lynch: Yes, but I wish Home Depot had started here in Boston instead of in Atlanta. You could have bought Toys R Us after they had 20 stores open and made a fortune on it the next fifteen years. You have to ask: why can’t this company go from 20 stores to 400 stores?
Tanous: There was something in one of your books that addresses your legendary stockpicking that rang a bell. Fidelity started inviting various corporations in for lunch or breakfast so that you could hear their stories firsthand. But then you contrasted those you invited with the companies who wanted to invite themselves over. Those companies were telling you the same story that they were telling everyone around the Street. Peter, you talk a lot in your books about communications, meetings, information sharing, and so forth, and that starts to give me a picture.
Lynch: Again, I’ve always said that if you look at ten companies you’ll find one that’s interesting. If you look at 20, you’ll find, two; if you look at 100, you’ll find ten. The person that turns over the most rocks wins the game. That’s the issue. If you look at ten companies that are doing poorly, you’ll probably find nine companies that there is not much hope for. But maybe in one of them, one of their competitors has gone out of business, or the plant that caused them a lot of problems has been closed, or they got rid of the division that was losing money. You’ll find one out of ten where something concrete has happened and the stock hasn’t caught up with it. If you look at 20, you’ll find two.
It’s about keeping an open mind and doing a lot of work. The more industries you look at, the more companies you look at, the more opportunity you have of finding something that’s mispriced. The theory is that the market is perfect and that all companies are fairly priced. And that is true in a majority of cases. If you find a company whose stock is on the new high list, generally they’re doing well and they have a good future. You might also find companies where the stock is depressed and they’re doing poorly, and you’ll also find out that the company is having problems.
But maybe you’ll find a company where the stock’s gone from 40 to 4, it has no debt, it has two dollars per share of cash, and they might be losing money but, remember, they have no debt. It’s a real challenge to go bankrupt if you have no debt. I find it interesting that people will buy a bunch of companies that are losing money. If you do, you might as well buy the company that has the good balance sheet and also has something going on that they can show – maybe a new product that is working out well, or something else. Each story is different.