02 January 2023

On today’s episode, Clay Finck reviews Peter Lynch’s best-selling book, One Up on Wall Street. Peter Lynch is known for managing the Fidelity Magellan Fund which achieved an average annual return of 29.2% per year from 1977 through 1990.

This episode is jam-packed with investing insights from one of the world’s greatest investors, so you won’t want to miss it.

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  • How everyday people can actually have an advantage investing in stocks over those on Wall Street.
  • Lynch’s stock investing philosophies and methods.
  • How he categorizes the stocks he invests in, in order to manage expectations.
  • What to look for when searching for a great company to invest in.
  • Why you should avoid companies that fall prey to what he calls diworseification.
  • The most common mistakes new investors make.


Disclaimer: The transcript that follows has been generated using artificial intelligence. We strive to be as accurate as possible, but minor errors and slightly off timestamps may be present due to platform differences.

00:00:03] Clay Finck: Hey everyone. Welcome to The Investor’s Podcast. I’m your host, Clay Finck, and on today’s episode, I’m going to be reviewing one of Peter Lynch’s books, One Up On Wall Street.

Peter Lynch is one of my very favorite investors to study because he is able to make investing in individual stocks much more approachable for the everyday person, and he’s really good at removing a lot of the financial jargon you might read in other books or see in the news.

[00:00:28] Lynch is famous for managing the Fidelity Magellan Fund for 13 years as he achieved an average annual rate of return of 29.2% per year from 1977 through 1991. One Up On Wall Street was originally released back in 1989 and since then it’s sold over 1 million copies. Lynch is an investing legend when it comes to picking stocks, so I definitely learned a lot from reading his book.

[00:00:57] During this episode, I’ll cover how everyday people can actually have an advantage investing in stocks over those on Wall Street, Lynch’s investing philosophies, how he categorizes the stocks he invests in, in order to manage expectations, what to look for when searching for a great company to invest in, why you should avoid companies that fall prey to what he calls doworseification, the most common mistakes novice investors make and much, much more.

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[00:01:24] Without further delay. I hope you enjoyed today’s episode covering investing legend Peter Lynch.

[00:01:34] You are listening to The Investor’s Podcast, where we study the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected.

[00:01:54] Now when it comes to thinking about the most well-known stock investors, Warren Buffett and Charlie Munger, of course come to mind, but Peter Lynch is also incredibly well known, so I figured I’d go through his book, one up on Wall Street and discuss some of my biggest takeaways from reading the book.

[00:02:10] Lynch says that despite living in a world of instant gratification, he invests the old-fashioned way by owning stocks where the results depend on the company’s ability to increase their earning. With the expectation that the share price will eventually follow. Generally, Lynch’s investment thesis in a company tends to play out over a three to 10 year timeframe or sometimes even more.

[00:02:33] Lynch definitely comes across as someone who just has an immense passion for stock investing. When he discovers a company that is potentially worth investing in, he just dives in and wants to know everything about the company that he possibly can. He’s reading their earnings reports, he’s talking to analysts, he’s talking to people that work at the company as well as even the company’s competitors.

[00:02:55] One thing that I thought that was different from reading Lynch’s work is that it almost seems like he is talking about stock investing as something you can almost get rich relatively quick on. He will mention multiple stocks I’ve increased by 10 x or 20 x over a five or 10 year time period. Which you know, is really pretty rare.

[00:03:14] So it seems to me that Lynch really wants to make stock investing a subject that really gets people excited so they dive in and really want to learn all they can about it. Warren Buffett, on the other hand, is not the type of investor that would tell you you should go out and look for stocks that have the potential to go up by 10.

[00:03:33] Rather Buffett’s much more well known for being the value investor type and being much more conservative and put a lot more emphasis on the potential downsides. Lynch’s work, however, did catch the attention of Warren Buffett. In 1989, Buffett gave Lynch a call letting him know that he loved one of the lines in his book, and it was related to holding onto your winners.

[00:03:55] The line in the book stated, when you sell your great companies and add to the losers, it’s like watering the weeds and cutting the flowers. Another one of Lynch’s very famous quotes is that more money has been lost in anticipating a downturn than in the downturn themselves. This especially rings true for investors after the great financial crisis as we went through one of the greatest bull markets the world has ever seen for equities.

[00:04:21] Lynch said in an interview with Fox that he’s confident that the market will be higher 10, 20, 30 years from now. He’s also confident that there will be many drawdowns along the way during the.com boom. People paid attention to the fact that stock prices were just soaring and all their neighbors and friends were getting rich by buying tech stocks.

[00:04:40] While an investor like Lynch is looking at a company’s earnings to help evaluate whether it’s a buy or sell during a stock boom, investors are only looking at the stock’s recent performance, whereas Lynch is really looking at the underlying fundamentals like any other great investor. I think that Lynch is focus on a company’s earnings and how the stock has performed relative to that earnings growth can really be a helpful reminder for us on what really drives a stock’s long-term perform.

[00:05:08] Lynch is very well known for being someone who believes that an amateur investor can succeed by picking tomorrow’s big winners and paying attention to the new developments in their environment, whether that be in the workplace, what people are purchasing online or in physical stores, or any sort of new enterprise that comes into fruition in their life.

[00:05:27] In fact, Lynch actually believes that any normal person can pick stocks just as well, if not better than the average Wall Street expert. Here’s a clip of Peter Lynch chatting about this idea with Charlie Rose during an interview in 2013.

[00:05:42] Charlie Rose: You still believe in the investment mantra that you were often credited as your mantra, which is invest in what you know.

[00:05:48] Peter Lynch: Yeah. Imagine you spent, you, you, you have a long time in your field. On my field. Imagine if you’re in a mall the last 30 years. You would’ve seen the gap. You would’ve seen Best Buy, you would’ve seen Circuit City. You would’ve seen these companies that are crowded doing something better and, and they’re buying biotechnology stocks. Or oil companies.

[00:06:02] It makes no sense. If you’re in the steel industry, you see it go from awful to better. Why don’t you buy a steel?

[00:06:06] Charlie Rose: Yeah, but we expect mutual funds to know that stuff. No, obviously you, you, if you’re managing, but they’re ahead of us. You know, if you look at Magellan you look at at, uh, at Black Rock, you think they must have access to the best information in the world.

[00:06:19] Peter Lynch: They don’t, they don’t have that. They’re not in the Steelers. They don’t see things get better, you know, the way, way they don’t see the chemical industry turning as soon as the people in the chemical industry do. I mean, you could be in the plastics, fields of lithium, whatever it is, people in the business see it first and that they see it first or, or they, the mall.

[00:06:34] Go ahead in a mall. Imagine the companies you’ve seen, the Dunkin Donuts, it goes on and on. Walmart, you know, stuff and shop. These are all kinds that really got better. Said, gee, I’m shopping there. I, I’m not saying people. If they want to investigate, I’ll do the same kind of research they do when they buy a refrigerator. They take your trip to Italy, do some homework.

[00:06:49] Charlie Rose: You know what the, do you know what is about this country? That is stunning to me. For the most part, we don’t do that about medicine and our health. Huh? We don’t do it. We are more interested in getting the best television right than we are the best.

[00:07:02] Peter Lynch: No, I, I agree. I mean, the diagnostics talk about improvements. The diagnostics today are so much better.

[00:07:07] Charlie Rose: Okay. The other thing is what advice we give to young investors who almost certainly will have more direct responsibility for their retirement savings, then their predecessors, of which I’m going to talk about later.

[00:07:16] Peter Lynch: Well, I think that the advantage of putting money into a retirement fund, Obviously a fairly fund I would prefer, but index on whatever it is, what’s some money aside that’s going to compound tax free. You start saving earlier. The numbers are amazing. Compounding. We’ll do good one. Amazing how you want it.

[00:07:31] Amazing. But, but until you want to invest directly individual stocks, start a paper portfolio, say, I’m going to buy these 10 companies and then write down in like five boats. Why? What’s the reason I bought those? And then keep checking year later what happened. Did they really keep growing or did a competitor come along, do a paper portfolio and you can do exactly what I did with a real portfolio and find out what am I good at? What am I bad at? Am I really good at turnarounds? Am I good at small growth companies? Maybe I pay it too high for stocks. You can do this very, you can do this over four or five years and learn what’s your skills and then specialize in that. I had owned thousands of companies. You the Irish Prison, all you have need is a few in a lifetime. Make a difference.

[00:08:08] Clay Finck: Now, Lynch doesn’t say that just because you and your friends really like going to Chipotle or you like shopping on Amazon means that you should go and buy these stocks, but he does believe that those are a good starting place to dig deeper because it’s already a company that you’re at least somewhat familiar with, said in another way.

[00:08:28] Liking a company’s products is a good reason to research the company further, but is not a good reason to own the underlying stock. Lynch also emphasizes that you don’t have to be right on every single stock in your portfolio. In fact, not even Lynch himself, or even someone like Buffett bats, 100% Lynch says that just batting six out of 10 puts you in a really good position because your losses in a company are limited to what you have invested while your gains over the years to come have unlimited potential upside.

[00:08:59] If you invested $1,000 in a bad company, the most you could lose is obviously $1,000. If you invest a thousand dollars in a great company, you could make 10,000, 20,000, or even more over the years to come. If you’re listening to this show, it’s very likely you’re aware that investing for the long run is where the really big money is made.

[00:09:19] Lynch says that nobody believes in long term investing more passionately than him, and he points out that is much easier to preach long-term investing than to actually practice. It’s so easy nowadays to get swayed by the headlines in the newspapers or follow the fed’s actions with interest rate hikes, or follow what’s happening on Twitter.

[00:09:39] Most of this up-to-date news is pretty irrelevant to the long-term investors, so it can be really difficult to keep that mindset and approach as we read these things every single day that incentivize the opposite behavior of long-term invest. Bear markets are of course, to be expected for stock investors as a market correction of 10% or more can happen every couple of years.

[00:10:02] On average, corrections of 20% or more happen every six years and severe bear markets or declines of 30% or more have occurred five times since the Great Depression, since the time this book was written. So you can probably add three more occasions to his total being the tech crash, the great financial crisis, and then the Covid crash.

[00:10:22] It’s foolish to assume that we’ve seen the last of the bear markets, and it’s important to keep in mind that we should only invest money that we know we won’t need over the next couple of years as we won’t be forced to sell at a loss. Lynch recounts that in order to be a true long-term investor, you need to hold through all of these downturns, meaning that you don’t try and time the market and constantly get in and get outta your positions, and then you incur capital gains taxes along the.

[00:10:50] If someone had invested $100,000 in stocks in July of 1994 and stayed fully invested for five years, they would’ve ended up with 341,000. If you had happened to miss the 30 best days in the market with the biggest gains, your end sum would’ve only been $153,000. So by staying invested, you would’ve doubled your end result and made sure you stayed in on those really good days.

[00:11:17] Those that are bearish on the market will state that the market’s overpriced, which seems believable, especially nowadays in 2022. The problem is that nobody really knows when a bear market will occur, so the people that are bearish on the market may be right, that the market is overvalued. For example, at the beginning of 2017, someone may have concluded that the market was far overvalued and they were going to get outta stocks and buy back in at a cheaper.

[00:11:44] The s and p 500 at the time traded at around $2,250. But 2017 was a great year for stocks. As the s and p 500 marched upward to nearly $2,900. Then it corrected down to around 2,400, which even with that correction, it’s still a higher price than the start of the year. The next correction would occur in March, 2020, and it would trade down from 3,400 down to 2300.

[00:12:11] So timing the markets is really difficult because you just don’t know when those bear markets are going to occur. And you don’t know how low the price is going to go during the bear market. Remember that the stock market over the long run tends to trend up into the right. Lynch says that markets at times do become overvalued, of course, but there is no point in worrying about it.

[00:12:33] A lot of the times, stocks climb a wall of worry and the worries never cease. At the end of the intro to his book, he states that quote, the basic story remains simple and never. Stocks aren’t lottery tickets. There’s a company attached to every. Companies do better or they do worse. If a company does worse than before, its stock will fall.

[00:12:55] If a company does better, its stock will rise. If you own a good company that continues to increase their earnings, you’ll do really well. Corporate profits are up 50 fold since World War II and the stock market is up 60 fold. Four wars, nine recessions, eight presidents, and one impeachment. Didn’t change that.

[00:13:15] Now, like I mentioned earlier, Lynch believes that amateur investors can do just fine in the markets because they can get a sense of what products are really good and what is going on in their environment. Five or 10 years ago, I’d imagined that it was pretty easy to see that many people were addicted to their Starbucks coffee.

[00:13:32] And you could see the line of cars at Starbucks, were going out of the parking lot when you drove by on your way to work. That’s probably a good indication that it’s a stock worth taking a look at. Or you might notice that Starbucks tastes a lot better than Dunking Donuts or vice versa. It makes a lot more sense to invest in a company you can actually understand and have experience with that company.

[00:13:54] Then invest in a company just because it’s hot and you might not really understand the underlying. Which is probably the case for a lot of tech companies today. You know, I just don’t understand many of these businesses. Lynch breaks up his book into three sections. Part one includes chapters one through five, which covers preparing to invest.

[00:14:14] Part two covers chapter six through 15, which covers picking winners, and part three is titled The Long-Term View for Chapter 16 through 20. In chapter one titled The Making of a Stock Picker Lynch describes how he first got introduced to the world of the stock market at the age of 11 because he was a caddy and got to be on a golf course with presidents and CEOs of major companies.

[00:14:38] Lynch went to graduate school at Wharton and was thrilled to get an internship at Fidelity, and right off the bat, he felt that what he learned at Fidelity was incredibly useful in learning how to pick stocks and much of what he learned in school was really setting him up to fail. If anything, Lynch stated that it’s hard to support the theory that the market is fully efficient when he knows somebody that has made a 20 fold profit on Kentucky Fried Chicken stock and further.

[00:15:04] In advance. They explained to him why the stock was going to rise as it eventually did. He stated his distrust of theorizes and prognosticators continues to this present day after doing a two year stent with the R O T C in Texas and Seoul, South Korea. Lynch joined Fidelity again full-time in 1969 and in 1977 he famously took over the Fidelity Magellan fund.

[00:15:29] In chapter two, Lynch described a phenomena in the investment world. He calls Street lag. Street lag. Described the tendency of many Wall Street firms to exclude a number of stocks from their investments, largely because other firms don’t follow it and don’t own it. This leads many companies essentially flying under the radar because many firms simply won’t find a company attractive until a large number of other institutions have recognized its suitability and respected.

[00:15:57] Wall Street analysts have put it on their recommended list. He uses an example of a company called The Limited, which is a clothing retailer who went public in 1960. The Limited wasn’t owned by any institution until 1975 and only had a couple of analysts following it as it only had a hundred stores. A second institution took ownership in 1979, and the company had gotten up to 400 stores in 1981.

[00:16:24] By 1983, the stock had risen by 18 fold from 1970. By the mid 1980s, many analysts started to pile in and put the company on their buy list in sort of a domino effect of more analysts making it appear that the stock was more worthy of attention. He lists example after example of companies that weren’t closely followed that ended up being really big winners.

[00:16:49] This brought Lynch to his other point that you’ll never lose your job by losing your client’s money In ibm. Many fund managers likely have a bias towards not looking bad, rather than stepping outside the box and purchasing companies that nobody else is buying. If you buy IBM and it goes bad, your brass will probably say something like, man, what is going on with ibm?

[00:17:10] If you buy a small noname company and it goes bad, your boss might say, what the heck is wrong with you? Because I really enjoy playing poker from time to time with friends. I love how Lynch compares the stock market to playing poker. To him, an investment is simply a gamble in which you’ve managed to tilt the odds in your favor.

[00:17:30] Learning how to play poker well can provide a very consistent long-term return to people who know how to manage their cards. We’re given limited information and the winners raise their bets when their position strengthens and get out when the odds are against. Losing poker players consistently hang on to the bitter end of every expensive pot, hoping for miracles and enjoying the thrill of defeat.

[00:17:54] In poker and on Wall Street. Miracles happen just often enough to keep the losers losing and keep them at the table. Also similar to poker, even when investors make favorable bets, occasional losses are to be expected, such as when one bet’s big with a top straighter top flush, only to be beat by a full.

[00:18:15] Great investors accept their fate and know that the right investing strategy will inevitably reward them. Over time. They’ve realized that the stock market is not pure science, where the superior position always wins. Lynch says that the stock market is a gamble worth taking as long as you know how to play the game.

[00:18:34] Remember that six out of 10 appropriately size bets is all it takes to succeed as a stock investor. Lynch urges investors to consider Three thanks prior to purchasing stocks. First, he urges them to consider their position on owning a house, touting the benefits of home ownership when done right, because real estate tends to appreciate over time and the bank allows you to use leverage in your purchase.

[00:18:59] Additionally, when people buy a house, they aren’t tempted to trade in and out of it, and the interest expenses are tax deduct. Second Lynch urges to only invest money that you won’t need for the foreseeable future as fluctuations in the prices of stocks might lead you to selling at a loss. If you need the money in the short term, say within two or three years.

[00:19:20] The third and most important consideration is that if you have the personal qualities it takes to succeed as a stock investor, he lists traits such as patience, self-reliance, common sense, a tolerance for pain, open-mindedness, persistence, humility, a willingness to do independent research and admit to mistakes.

[00:19:41] Understand human psychology among others. One of the most important of these is likely psychology as investors tend to be bullish and bearish at inopportune times due to recency bias. I touch more on the psychology of investing at the end of this episode. Volatility is definitely something investors should become more comfortable with.

[00:20:01] Lynch’s Magellan fund declined between 10 and 25% on eight separate occasions in just 13 years. The really brilliant thing about the stock market is that you don’t have to be a forecaster and be able to know and predict where the market is heading. If Peter Lynch, Warren Buffett, and Howard Marks know they can’t consistently predict where the market is heading in the short term, then why should you be able to as a less sophisticated investor?

[00:20:27] The good news is that buying and holding quality companies can still yield exceptional results when held for the long haul. Many professionals have a lot to say about the stock market in general, but remember that when you are buying stocks, you are buying ownership in a real company, producing real goods and real services.

[00:20:45] If a company is able to continue to increase their earnings per share year after year, then over the long run odds are that you’ll have a favorable outcome. That concludes my summary of part one of the book. Moving along to part two, which covers picking winners, which covers a lot of different topics, including how to exploit an edge, the characteristics of a great company, the questions to ask in researching a stock, how to monitor a company’s progress among other things.

[00:21:14] As I mentioned earlier, Lynch believes that the best place to begin looking for winning stocks is looking at your own backyard and what is popular in your daily life. Just thinking about companies I interact with today that potentially are good stocks to buy, Airbnb is an app I use when I travel. Apple has multiple products I use every single day.

[00:21:33] Amazon is a site I purchase from every week or two. I use Google Search and Gmail all the time. These are just simple examples of companies that provide a lot of value to me and don’t have a lot of competition when just looking at first glance. So it’s worth taking a look at their stocks. Another great place to look is looking at the industry you work in.

[00:21:54] For example, I used to have an eye on the health insurance industry as that was my line of work, and I noticed that UnitedHealthcare was one of the leaders in selling senior health products, which is really hot with the baby boomers hitting their retirement years. Sure enough, the company is one of the extremely good performers over the past 10 years or so.

[00:22:14] Investing in an industry you are more familiar with than most other people is a really simple way to get in the edge and be more comfortable with the companies you’re buying and holding. For Peter Lynch, he saw firsthand the massive boom that was occurring in the mutual fund industry. Although Fidelity wasn’t publicly traded, he could have just as easily purchased a stock in a company like Drefus, which went up a hundred fold from 1977 to 1986.

[00:22:41] Many other mutual fund companies did exceptionally well as investors flooded in toward mutual fund investments. Lynch categorizes stocks into six categories, slow growers, stalwarts, fast growers, cyclicals, asset plays and turnarounds. Slow growers are companies that are much more mature, that have low to mid single digit growth rates in their top line revenue.

[00:23:05] Most industries and companies begin as fast growers and eventually transition to being a slow grow. Another sign of a slow grower is a generous and steady dividend since they don’t have the opportunities to reinvest back in the company at high rates of return. Lynch states that you won’t find slow growers in his portfolio because slow growers often equate to slow growing stocks.

[00:23:28] Stalwarts are the next step up from slow growers. They’re still mature companies, but they’re growing their top line revenue a bit faster, maybe in the high single digits or lower double digit. Some companies today that I would categorize as a stalwart would be Coca-Cola, Berkshire Hathaway, dollar General, and Walmart.

[00:23:46] There’s a bit more upside potential in growth opportunities in Stalwarts. Lynch says that at times he’ll be able to identify a stalwart trading at a discount that he buys and waits for it to increase 30 to 50%. More towards its fair value before selling it and allocating the money elsewhere. He likes stalwarts because they will perform better during a recession than the other higher growth companies.

[00:24:09] Then there are the fast growers that Lynch just loves, and these grow at around 20 to 25% per year. Lynch says that if you invest wisely here, this is where you’ll find the land of 10 to 40 baggers or even. This may be a bit optimistic relative to when Lynch was investing, but getting a 10 or 40 bagger in today’s market is likely much more difficult than when Lynch was investing.

[00:24:33] And Lynch actually prefers that these fast growing companies are in a slow growing industry, such as the way Walmart grew in retail, and Marriott grew in the hotel industry. The problem with fast growers is that when their growth slows down, they tend to get punished by the market, as we’ve definitely seen in 2020.

[00:24:51] A good place to start when investing in fast growers is to ensure that the company has a strong moat and competitive advantage, as well as a strong balance sheet in positive earnings and free cash flow. Cyclicals are companies that have rising and falling profits in a fairly unpredictable manner. Auto airlines, oil, steel, and chemical companies are all examples of cyclicals.

[00:25:14] Cyclicals can get more novice investors in trouble because they might assume it’s a stalwart that will steadily grow, when in reality it can quickly correct 50% if they buy in the wrong part of the cycle. Turnarounds are companies that are close to extinct whose investors are betting on the company’s ability to pull themselves out of their troubles.

[00:25:33] Successful turnarounds aren’t very common, but when investors identify the right ones, they can pay off handsomely. Some companies are in need of restructuring due to what Lynch calls diworseification, which is when a company makes a poor acquisition to try and expand its competitive position. An asset play is any company that is sending on something valuable that you recognize, but the overall market and Wall Street is overlook.

[00:25:58] This is similar to Benjamin Graham’s cigar bed approach of buying something whose market value was trading below what the company’s underlying assets were valued at minus any debt. These definitely aren’t as common nowadays with markets being much more efficient in information flowing, much more freely, catching these easy mispricings.

[00:26:16] Asset plays can also exist in something that’s more intangible. For example, what should the value of a Netflix subscriber be when compared to traditional cable? And is the market undervaluing a Netflix subscriber? And by how much? This is something that Tony Coyier from Oakmark discussed with me on our millennial investing show earlier this year with regards to Netflix.

[00:26:37] That is episode MI 1 53 on the millennial investing. Once you find a stock, you want to be able to categorize it in roughly one of these six categories. You also want to be aware that it might switch categories in the future. Eventually, a fast grower transitions to a stalwart or competition floods in and it turns into a slow grower.

[00:26:58] Lynch is most interested in companies that are under followed. Which is oftentimes a business that has a boring name and a boring business. Companies like Texas Roadhouse, monster Beverage and Dominoes Pizza come to mind as these are companies that many investors probably aren’t too interested in as they’re in the food and beverage industry, but these were some of the best performers over the last 10 to 20 years.

[00:27:21] Other hunting grounds are companies with little to no analysts that follow it as well as little to no institutional owner. Lynch also talks about industries that are shunned or they’re somewhat of a depressing sentiment around it. Lynch uses the example of funeral homes and the company mci. I think that today, this reminds me of a company like Meta.

[00:27:41] There’s just so much negative sentiment around it, and people say that the Facebook app is being disrupted and such. The strong negative sentiment has led to many value investors even adding it to their portfolio. Other things Lynch likes to find is companies that have their own niche that they’re really good at doing.

[00:27:59] This falls in line with Buffett’s idea of e moat. If a newspaper company is the only newspaper in town and you see the businesses improving year after year, then that’s a great business to own because they aren’t getting disrupted until, of course, the internet comes along and forces them to pivot. The final two items he lists to look for in a company is that the insiders are buying the stock..

[00:28:20] Or they own at least a sizable position in the company themselves. So the interests are aligned between the two as a shareholder and those running the company. Also, he wants the company to be buying back their own shares. Like Buffett always says, share buybacks are one of the easiest ways for a company to return capital back to the shareholders in his tax efficient way. Share buybacks show that the company has the shareholders in mind, assuming that they don’t have better opportunities to invest in within the company.

[00:28:48] Lynch isn’t afraid to let us know what stocks he would avoid as well, the first of which would be the hottest stocks in the hottest industry. These stocks are always in the news and on the front pages of newspapers, and it’s what everyone is talking about. Hot stocks can go up a lot really quickly, but the only thing holding them up is hope and thin air to support them giving them the chance to fall.

[00:29:11] Just as quickly Lynch says that quote, if you had to live off the profits from investing in the hottest stocks in each successive hot industry, you’d be on welfare. The reason he avoids these industries is because high growth in hot industries attract a very smart crowd that want to get into that business.

[00:29:29] As soon as Peloton is growing at a hundred percent per year for a number of years, eventually money flows in to try and steal their market share with a very similar product at a more attractive price. Oftentimes, the hot industries are led by a company that is touted as the next Amazon or the next Apple like opportunity.

[00:29:48] I believe people would call a Peloton the next Apple, claiming that the bikes were their way to lock customers into their subscription model. Oftentimes when a stock is claimed as the next Amazon or the next Apple, it has hit the end of its stays of prosperity. Lynch is pretty well known for the idea of what he calls diworsification, which I mentioned earlier.

[00:30:08] This is really just a different way of saying diversification, but it’s a bad kind of diversification. Diworsification essentially means that there’s always the corporations who don’t have any ways to grow their own business, so they go out continuing to acquire other businesses that end up not being the best use of their capital.

[00:30:26] You’ll oftentimes see this in companies that have matured and are no longer innovating, so they’re trying to acquire their way to growth, to compensate for their lack of innovation or creativity. Acquisitions are tricky to get right and oftentimes controversial as the prices paid tend to be fairly high, especially for companies that are trying to buy smaller competitors that are growing quite fast.

[00:30:49] One recent example of this is Adobe acquiring Figma, which is a much smaller company that is growing their top line very rapidly. They paid around 20 billion for Figma, and it was expected to add 200 million in annual recurring revenue for Adobe. The key to successful acquisitions is to add synergies and allow the sum of the parts to be greater than if the companies were separate.

[00:31:13] For example, Adobe might have synergies to allow Figma to have accelerated growth or vice versa for Adobe’s core business. Ideally, the best acquisitions are in related businesses. In Chapter 10, Lynch dives into the importance of the company’s earnings and assets. Assuming the company doesn’t get liquidated and sold off earnings are the most important aspect of valuing a business in the long run.

[00:31:39] The stock is going to be very highly correlated to its underlying earnings. As most of our listeners are aware, the PE ratio is a good indicator of how the market views a stock. A company with a PE of 10 or less is likely predicted to have little to no earnings growth in the future. A company with a PE of say, 30 or more, tells you that the market puts a premium on that company’s earnings because they expect earnings to be higher in the years to come.

[00:32:05] To use two companies, just as a general example, at and t is a company with a PE ratio of seven. So for whatever reason, the market hasn’t priced in much earnings growth for the company going forward. While Costco has a PE of 40, likely because the market has a lot of confidence that they will be able to continually increase those earnings year after.

[00:32:26] As they really have a strong moat and they’re able to fend off their competitors from taking the share of their earnings. So looking at the PE ratio can give you a general idea of how the market views a company. When a company has a relatively low pe, but you have a good understanding of the business and believe that the earnings will be higher in the years to come, then that may be an opportunity to buy a company at a really good price.

[00:32:51] Alphabet, for example, is a company that I don’t expect to be disrupted anytime soon with how powerful their assets like Google search and YouTube are. Yet they’re only trading at a PE of around 20. However, it’s also important to keep in mind that maybe the market is right and there is a good reason for the company to be trading at the PE ratio that it is, and we should be mindful of Buffett’s idea of owner’s earnings and make necessary adjustments to those earnings that are reported by the company.

[00:33:18] We should also be hesitant to compare the PE ratio between companies that are in different industries. Just because at and t has a PE ratio of seven doesn’t make the stock cheap, and just because Costco has a PE of 40 doesn’t make the stock expensive. We have to look deeper into the company and understand the industry they operate and before we assess the company’s valuation and if it’s under or overvalue.

[00:33:42] Lynch lists five ways a company can increase its earnings. A company can reduce costs, raise prices, expand into new markets, sell more of its product in current markets, or revitalize close or dispose of a losing part of their business. These are things to consider as you develop an understanding of a business.

[00:34:02] When Lynch is analyzing a business, he wants to develop a story around it, why would he want to own it? And what has to happen for the company to increase its earnings in the future in order for the stock to increase as well? He uses Coca-Cola as an example of a potential stalwart. The story might be Coca-Cola is selling at a low end of its historical PE range, but its earnings growth has accelerated over recent.

[00:34:27] The company has improved in several ways. It’s sold off half its interest in Columbia. Pictures to the public diet drinks have sped up the growth rate dramatically. Last year, the Japanese drank 36% more Cokes than they did the year before in the Spanish, up to their consumption by 26%. And because of these factors and others, Coca-Cola may do better than people think.

[00:34:47] And this is an old example from the book, just to give you an idea of how Lynch develops a story. You’ll want to learn as much as you can about the company in order to develop a story, and the more you know about them, the better you can understand the company’s competitive position, which is really critical to a company’s continued growth.

[00:35:05] LaQuinta was another company that Lynch went on to explain the story of this was a stock he purchased that end up increasing by 11 x over a 10 year period. In his research, he discovered that LaQuinta was making a lot of progress in the hotel. They were a middle of the road type hotel that offered a lower price than Holiday Inns, but a higher quality than the low budget hotels one could stay.

[00:35:29] La Quinto was very strict on minimizing costs, so they could offer a similar hotel experience to holiday nn, but at a price that was 30% cheaper. They eliminated the wedding area, conference rooms, kitchen area, restaurant, none of which contributed to bottom line profits. They also kept costs low by building 120 room ends instead of 250 rooms.

[00:35:51] They got really savvy in minimizing their costs without giving up too much in revenue. The company at the time was growing at 50% per year in only trading at an earnings multiple of 10, which made it an incredible bargain. When analyzing a stock, it’s also really important to remember that turnarounds often don’t come into fruition, so rather than guessing whether a company will turn the corner and improve, it’s better to stick with business models that are proven and able to stand the test of time.

[00:36:20] As far as digging into the numbers of a company, Lynch keeps it pretty simple. In his book, in chapter 13, he touches on which business segments the company’s sales come from, the PE ratio, the cash and debt on the company’s balance sheet, the debt to equity ratio, the dividends, the company’s book value, which isn’t as important now as it was back then, and then the company’s hidden assets that aren’t included in the book value today.

[00:36:44] This would include things like intangible assets for technology, c. Then he looks at the cash flow in the company’s capital requirements. As I mentioned during my episode, covering Apple, episode number t i P 4 89, Buffett points out that Apple requires very little capital investment relative to a company with a lot of tangible assets like Berkshire Hathaway, which makes Apple a very great business to own.

[00:37:09] Finally, he looks into the expected growth rate of the company and analyzes if the company has sufficient pricing. As I’ve read through the book, I notice a lot of similarities in what Lynch is looking for in a company to Buffett and Munger, as you mentioned, that is better to purchase a stock with a multiple of 20 that’s growing at 20% per year than a stock with a multiple of 10 that’s growing at 10% a year, which gets at the Buffett quote of, it’s better to buy a waterfall company at a fair price then a fair company at a wonderful.

[00:37:38] The compounding effect of a fast grower that is able to continually grow fast really adds up, and when it’s held for long enough, whether you paid 40 or $60 per share really didn’t matter because great companies do so well and grow into and beyond their original valuation. If you started with $1 per share in earnings, and that amount grew by 20% per year for 10 years, you’d have $6 in 19 cents and earnings at the end of year 10.

[00:38:06] Whereas if earnings only grew by 10% per year, the earnings per share would be $2 and 59 cents. In his book, Lynch recommends checking in on a company’s story every few months to ensure that it’s playing out at least as well as you expected it. He breaks companies down into three stages in terms of where they’re at in their growth cycle.

[00:38:27] During the startup phase, the company is still working out the kinks and the basics of the business. The rapid expansion phase is when a company has its business figured out, and they’re expanding into new markets. Then the saturation phase is when the growth slows down, and there aren’t very many new opportunities to expand the business.

[00:38:45] The first phase is the riskiest, because the success of the business isn’t yet established. The second phase is much safer in where a lot of the money is made, assuming you pay the right price. The third phase is problematic for investors that want to be in a company with future growth potential rather than a more stable company with steady cash flows and a safe dividend, assuming you’re invested in the company.

[00:39:08] In the second phase, you’ll always want to be mindful of where you expect the future growth to come from, and see if the company is continuing to execute on that. Zoom out and look at the company’s earnings reports from a few years ago. Where did they expect future growth to come from? How much did they expect to grow?

[00:39:27] Then compare that to what actually happened. Did they grow faster than expected and did the growth come from where they anticipated it would? Most people probably don’t do this, but you should also learn to divorce the stock price from the actual fundamental. If you tune into my episode discussing Jeff Bezos and Amazon, you know that while Amazon’s stock dropped 90% during the tech crash, the company’s fundamentals were getting better and better with nothing but growth forecasted into the future.

[00:39:56] Just because the stock is going up doesn’t mean the company’s fundamentals are improving, and just because the stock is going down doesn’t mean the fundamentals are decline. Be sure to verify the fundamentals yourself and not create a story based purely on what the stock price is doing. In chapter 15, Lynch included a final checklist that we can go through for each of the type of stocks he listed, and this chapter seems to summarize much of what was covered in the chapters leading up to it.

[00:40:24] For each stock in general, he wants to understand the PE ratio the company is trading at the institutional ownership. To give him an idea of how well known and followed the company is, the insider ownership and stock repurchase activity. The company’s recorded earnings growth to date, what the balance sheet looks like, and if the company is financially strong as well as their cash.

[00:40:46] Some additional rules of thumb to keep in mind include understanding the companies you’re investing in and developing a story around the company. Small companies have the potential to make big moves while bigger companies don’t have as much of that opportunity. Look for small companies that are already profitable and have a proven concept that can be replicated, be suspicious and skeptical of hot stocks in hot industries, as well as companies growing at over 50% per.

[00:41:14] Long shots almost never pay off. Invest in simple companies that are dull, mundane, and out of favor. Put a strong emphasis on the multiple you’re paying for the company. Look for managers in which the management team owns a lot of the stock, and be sure to do your own research prior to investing in any company.

[00:41:33] Lynch doesn’t provide a hard rule to how many stocks and investors should. But he does suggest to consider purchasing any stock in which you have an edge and you’ve uncovered an exciting prospect that passes all the tests of research. This could lead to a portfolio of five stocks for you or a hundred stocks.

[00:41:51] It just depends on how much time and effort you’re willing to commit to the process. Lynch owned a lot of stocks, partly because of his size, but also because the more stocks he owned, the better chance he would own some of the big winners that went up tenfold or. Lynch isn’t one to hold cash to try and time the market because he is just full of ideas and opportunities to invest in.

[00:42:13] So he’s always fully invested into the market. It was in chapter 16 in which Lynch mentioned the quote that Buffett called him about that some people automatically sell the winners stocks that go up and hold onto losers stocks that go down, which is about as sensible as pulling out the flowers and watering the we.

[00:42:33] Others automatically sell their losers and hold onto winners, which doesn’t work out much better. Now, what he’s really getting at here is that to sell your winners when they go up, ignores what is actually happening within the company. If a company’s stock price goes up because the fundamentals have improved, then it’s silly to want to sell it for that same reason.

[00:42:53] If the fundamentals have gotten worse and the future prospects for the company don’t look as bright, then you may want to consider selling your position. So you want to look at the underlying fundamentals of the company and if the story has changed, the stock price doesn’t really tell us anything about the fundamentals of the company, and sometimes the fundamentals and the stock price move in the opposite direction.

[00:43:16] He also dedicated a chapter to when you should buy and sell stocks. Of course, the best time to buy stocks is during a panic in a market crash because that’s your opportunity to buy great companies at a discount. It can be really difficult to buy during these times because your stomach and your gut will be telling you to sell and many people you know will likely be selling as well.

[00:43:38] Many times throughout the book, Lynch mentions the stock market crash in 1987, which is referred to as Black Monday. On that one single day, the Dow Jones fell by over 22%, and central banks around the world needed to step in and provide liquidity to prevent defaults among financial institutions. This then left to a swift recovery in the markets making this crash like all the other crashes.

[00:44:03] Historically, great buying opportunities for long-term investors. Because of all the noise in the markets with regards to inflation, the war, the Federal Reserve, interest rates and so on, it can be really easy to get swayed by others, bullish or bearish opinions, and continually get in and get out of the market.

[00:44:22] But Lynch takes the approach that for the most part, you shouldn’t consider external economic conditions when buying and selling. For Stalwarts in particular, which are the more mature companies, Lynch tends to try and purchase these when they’re at the lower end of the PE range and sell them when they’re at the higher end.

[00:44:40] This generally falls outside of Buffett’s approach of buying a stock and holding it forever. But Lynch seems to be the jack of all trades and be exposed to different types of companies and not just go for the fast growers. He may also sell a stal war if their growth rate has slowed and doesn’t see it picking back up anytime.

[00:44:58] For fast growers, the last thing he wants to do is sell a 10 bagger too early. But if the valuation gets so ridiculous, then he may consider taking some chips off the table in order to allocate to better opportunities. Other signs to potentially sell a fast grower are slowing growth in maturity. Key executives leaving to join a rival, or there is a lot of hype around the stock on Wall Street.

[00:45:21] Lynch, for the most part, likes to hold on to fast growers, even if they appear to be slightly overvalue. Lynch, like many other great investors, is very aware of human psychology and the natural mistakes people make with regards to the stock market. In chapter 18, he lists what he calls the 12 silliest and most dangerous things people say about stock prices.

[00:45:43] It’s all briefly touch on some of these that I thought were pretty noteworthy. The first saying some people might bring up is it’s gone down this much. It can’t go much lower. A company that is being disrupted and seeing declining sales year after year is a company whose business model is in jeopardy.

[00:46:00] Polaroid is the example Lynch brings up in his book. It’s a stock that just continue to drop and drop, and those who believed in the company would’ve believed that eventually the stock price would turn. But it’s important to remember that there is no limit to how far a stock can. I think this is especially important for a company that isn’t free cash flow positive because if credit conditions are tight and the company can’t make money through their business operations, then eventually they may have to file for bankruptcy.

[00:46:29] Great companies are able to control their costs, have a strong balance sheet, and be free cash flow positive so they can weather through these tougher economic conditions just fine. But still, even the great companies can have their stock prices fall a lot further than you might think. So that’s why you have to understand the fundamentals as well.

[00:46:47] The second line Lynch mentions is you can always tell when a stock hits a bottom. Bottom fishing is a popular investor pastime, but it’s usually the fishermen who gets hooked. Trying to time the bottom in a falling stock is pretty close to impossible. Lynch says that it is normally a good idea to wait until the falling knife hits the ground and sticks for a while before you try and grab it.

[00:47:09] Nobody is ever going to be able to consistently time the bottoms and the stocks decline. The third one is, if it’s gone this high already, how can it possibly go higher? There is no arbitrary limit to how high a stock can go. So if a great company has already gone up tenfold, that doesn’t necessarily mean the stock is expensive.

[00:47:30] Amazon is a great example of this. You could have recognized that Amazon was a great company with great fundamentals 20 years after it had gone public in 1997, and you still have benefited from owning the stock even though you were relatively late to the game. The fourth one is, it’s only $3 a share.

[00:47:48] What can I. This is a psychological mistake investors make of thinking that just because the share price is low means that the stock is a bargain, which is anything but the truth. It doesn’t matter whether a stock costs $50 a share or $1 a share. If it goes to zero, you lose everything either way. The fifth saying is eventually they always come back, which is very similar to the first mistake of assuming that a stock can’t go any lower.

[00:48:14] He also touches on anchoring where the mistake is. When it rebounds to a certain price, then I will sell. Investors oftentimes assume that just because of stock, like Tesla was just over $300 a few short months ago, then it should rebound to that price point in the near future. This psychological bias of anchoring leads many investors to holding losing stocks just because they don’t want to actually click the sell button and incur the loss, even though they may realize that the investment thesis has been broken, which I’m not applying to Tesla stock either way.

[00:48:47] I’m just using it as an example. Since it’s pretty volatile, the market does not care whether you own a stock or not, and it certainly doesn’t care how much you paid for a stock in the past. Another common mistake is investors becoming too impatient in wanting something exciting to happen. Merck was a company that deeply tested investors, patients from 1972 to 1981, the company grew their earnings at an average rate of return of 14% per year, yet the stock went nowhere.

[00:49:18] Then the market started to reflect the reality of improved fundamentals of the business as a stock shot up by fourfold in the next five years. Remember that in the long run, stock prices tend to follow earnings. To round out the chapter Lynch explains that the single greatest fallacy of investing is believing that when a stocks price goes up, you’ve made a good investment.

[00:49:41] This may lead someone to purchase more of the stocks that went up and selling the stocks that went down. Therefore, being more influenced by the moves in the stock prices rather than the changes in the fundamentals of the. For the most part, short-term price fluctuation should be disregarded by long-term investors.

[00:49:59] Now, after reading this book or listening to this podcast episode, many may believe it is time to go out and start investing in individual stocks. However, beating the market overall can be really difficult. And without a good understanding of individual stock investing in the proper amount of research, it’s probably best to just buy an index fund that tracks something like the s and p 500 and really save you the extra work if you’re not interested in picking individual stocks.

[00:50:26] So it’s important to be mindful of just how difficult it can be to beat the market. However, Lynch’s book, One Up On Wall Street is a great book to pick up if you are interested in learning more about individual stock investing in building long-term. That wraps up my biggest takeaways from reading One Up On Wall Street by investing legend Peter Lynch. If you’d like to pick up the book yourself, I’ll be sure to link that in the show notes. Thank you so much for tuning into today’s episode. I really appreciate everyone’s support of the podcast as of late. With that, I’ll see you again next week.

[00:50:46] Outro: Thank you for listening to TIP. Make sure to subscribe to Millennial Investing by The Investor’s Podcast Network and learn how to achieve financial independence.

[00:51:10] To access our show notes, transcripts or courses, go to theinvestorspodcast.com. This show is for entertainment purposes only. Before making any decision, consult a professional. This show is copyrighted by The Investor’s Podcast Network. Written permission must be granted before syndication or rebroadcasting.


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