Chapter 3

PETER LYNCH

Managed Fidelity’s Magellan Fund from 1977 to 1990

Popularized the theme “Invest in what you know”

Author of One Up on Wall Street and Beating the Street

 

 

 

 

 

From his office in Boston, Peter Lynch plays the role of investment guru to the current group of portfolio managers at Fidelity Investments.

“I guess that’s what an old fund manager is—a guru,” he laughs.

Well, not just any fund manager. If you had invested $1,000 into Lynch’s Fidelity Magellan Fund in 1977, you would have had $28,000 by the time he retired from managing the fund in 1990. Not impressed? Look at it this way: If you had put $100,000 of your individual retirement account (IRA) savings into his fund when he started managing it, 13 years later, without adding another dime, you would have had $2.8 million. How does early retirement sound?

Lynch’s returns averaged a remarkable 29.2 percent per year during that period, beating the S&P 500 in all but two years. “I loved it. It was great fun,” Lynch says. “I just didn’t like the hours. Twenty-four/seven wasn’t enough. You could spend 24/7 just looking at insurance companies. There weren’t enough hours in the day.”

And when you talk to Lynch, you realize he probably puts a lot into a 24-hour day. If the speed at which he talks reflects the speed at which he thinks, there’s a lot of brainpower being put into his research. He says, “I have a very small transmission. My gearbox is overdrive and off. And you can’t sort of run a fund.”

Now, as research consultant at Fidelity, he meets regularly with the current fund managers, offering them his down-to-earth advice on how to invest successfully in a financial world that seems almost impossible to negotiate.

The striking thing about Lynch’s approach is that he makes it sound so simple:

You ought to be able to explain what you own to an eight-year-old in two minutes or less [and] why you own this thing. If you don’t understand it, you’re really going to get in trouble.

And while Wall Street has become peppered with technical analysts who look at charts, and quant fund managers who back-test all kinds of theories by computers looking for an advantage that isn’t obvious in the balance sheets, Lynch’s approach comes across as refreshingly basic:

“There’s a 100 percent correlation between earnings and a stock. These are not lottery tickets. Behind every stock is a company. If the company does well, the stock does well. If the company does poorly, the stock does poorly.”

Lynch recalls a time he was called upon to predict the future of Dell’s stock—by Michael Dell himself.

“I remember we were at some big meeting seven or eight years ago, and somebody said to Dell, up on the stage, ‘What’s your stock going to do?’ And he said, ‘Why don’t you ask Lynch?’ I was out in the audience. And I said, ‘Listen, if you earn a lot more money five years from now it’ll be higher, and if you earn less it’ll be lower.”

He also believes that you should look at the world around you to find opportunities on Wall Street. “Invest in what you know” is his classic but down-to-earth advice. For instance, he bought L‘Eggs for his mutual fund because his wife had tried on the stockings and raved about them. And his investment history is full of household names that may not have been household names when he first put money into them: Chili’s, Dunkin’ Donuts, Stop & Shop, and many others.

“I missed Wal-Mart. If I had spent more time in Arkansas I would have done much better with Wal-Mart, but I never saw the stores,” he says. “You’ve got to know what you own, because as the stock goes down, you can get shaken out in a market correction.”

And though he looks for great leadership, he doesn’t count on it, which leads to one of his better-known sayings:

“Go for a business that any idiot can run—because sooner or later, any idiot probably is going to run it.”

One of his long-held goals is finding a stock that goes up tenfold—a “ten-bagger,” as he coined it based on baseball’s vernacular for doubles, triples, and home runs (two-, three-, and four-baggers).

But while Lynch is appropriately revered for his stock-picking prowess, he didn’t get it right every time.

“Be flexible and have no bias and learn from your mistakes,” he says.

It doesn’t seem like a track record of 29.2 percent per year would include many mistakes, but even Peter Lynch makes them. Including his best one.

Peter Lynch’s Best Mistake, in His Own Words

It was 1982 or 1983. I was at a Robinson Humphrey conference in Atlanta, and after it was over I went to see Home Depot. They had gone from four stores to six, and all the stores were in Atlanta. Arthur Blank was the president, and was one of two guys really running it. And I had gone to see maybe four of the six stores.

I bought some stock, and like an idiot I sold it two years later; then it went up 25-fold after that.

It’s great if you’re right six times out of 10 times, but you want your winners to offset your losers. You can be wrong a lot, but if your winners can go up threefold, fivefold, 20-fold, you can have a lot of stocks that you lose 50 percent on. You don’t ever want to miss one of these enormous stocks.

And I was there at the creation of this thing, I was really early. But I never stayed in touch, and I did a total brain cramp on it. And it went up probably 50-fold after I sold it.

I made a triple on it, but that was just stupidity. If I had just kept in touch, you know, now there are 20 stores out there, now 40, and now up to 400 with no competition.... They offered customers a good value; they had a good balance sheet, not very cyclical at all—Iwouldn’t have gotten shaken out at all. It could have been a ten-bagger.

I still try to figure out what was going on in my brain.

There were a lot of winners, like Au Bon Pain Co. Inc., which became Panera Bread Company—it was a huge winner, but I stayed with it—Stop & Shop, Dunkin’ Donuts, La Quinta Motor Inn, Taco Bell, and other ones. But this one....

Warren Buffett called me—I think it was 1989 or 1990. And he said, “I’m doing my annual report and I’d love to use one of your quotes in your book—the one about how‘selling your winners and holding on to your losers is like cutting your flowers and watering your weeds.”’ And I said, “Sure, go ahead and use it.” And that was the mistake I made. Here I was, cutting the flowers and watering the weeds.

It was a great company: a beautiful balance sheet; great record; huge return. It made money very fast; there was a lot of high morale among employees. And they were in only a few states when I sold it. It’s different when you’re in every state and a competitor comes along like Lowe’s—that’s a different story. But that was two decades later.

 

Q. How would you have “stayed in touch”?

I would have visited one of the stores every six months, or called a couple of Wall Street analysts, or called the company every three months, just kind of to update how they’re doing. How are the stores doing? What new markets have you gone into? How are the old stores doing? It’s all public information; I just would have been in touch. Nothing technical, but what new departments are you starting, and what departments are weak? Who are you competing against? Until then itwas basically mom-and-pop shops out here; there were very few of these large do-it-yourself shops. They really helped the consumer out.

 

Q. Does it still bother you?

No, but it’s an example that if you’re right, you want to let your winners run. In your lifetime you get very few stocks that go up tenfold—I call it a ten-bagger. You don’t want to miss those. And this was like a 25-bagger, or a 30-bagger. This stock—well, the prior year it was under a dollar. You could buy it in 1983 at 25 cents. So it went from 25 cents to $50.

I learned from that if they’re really a superior company, watch and ask: Do they still have that competitive advantage? Do they still beat the mom-and-pops? Do they still have no national competitors? Are their existing stores still growing?

Don’t sell it. Keep checking up on it. Don’t be stubborn, of course. Just because a stock went up doesn’t mean it has to go up more; there has to be a reason for it. This stock went up probably a hundredfold, and their earnings went up a hundredfold.

Don’t sell your winners too soon. But stay in touch. You want to make sure the story’s still valid.

About Peter Lynch

Peter Lynch is vice chairman of Fidelity Management & Research Company (FMRCo.)—the investment adviser for Fidelity’s family of mutual funds—and an advisory board member of the Fidelity funds. Fidelity Investments is the largest mutual fund company in the United States, the number one provider of workplace retirement savings plans, the largest mutual fund supermarket, a leading online brokerage firm, and one of the largest providers of custody and clearing services to financial professionals. Mr. Lynch was portfolio manager of the Fidelity Magellan Fund, which was the best-performing fund in the world under his leadership from May 1977 to May 1990. When he took over the Magellan Fund, it had $20 million in assets. By the time he retired from the fund, it had grown to over $14 billion in assets and had over a million shareholders. Magellan became the biggest fund in the world in 1983, and it continued to outperform all other funds for the next seven years.

Mr. Lynch joined Fidelity in 1969 as a research analyst and was later named director of research. During his tenure at Fidelity, he has served as a managing director of Fidelity Investments, an executive vice president and director of Fidelity Management & Research Company, and a leader of the growth equity group. His first book was the best seller One Up on Wall Street. His second book, Beating the Street, remained #1 on the New York Times best-seller list for eight weeks. His books have been translated into several languages, including Japanese, Swedish, Korean, German, Spanish, French, Polish, Hebrew, Portuguese, and Vietnamese. In 1995, Mr. Lynch co-authored Learn to Earn, a beginner’s guide to the basics of investing and business.

Before joining Fidelity, he served as a lieutenant in the U.S. Army for two years.

Born in 1944, Mr. Lynch received a bachelor of science degree from Boston College in 1965 and an MBA from the Wharton School at the University of Pennsylvania in 1968. In 1994, he was named Outstanding Alumnus by the Wharton School. He is a fellow with the American Academy of Arts and Sciences and a member and former director of the Boston Society of Security Analysts.

Mr. Lynch is actively involved with a large number of civic and not-for-profit organizations. He has been recognized with several awards for his efforts, including the National Catholic Education Association 1992 Seton Award, the Massachusetts Society for the Prevention of Cruelty to Children 1993 Family Award, and the 1997 United Way Bay Leadership Award. This year marks his twentieth year as chairman of the Inner City Scholarship Fund, for which he has helped raise over $70 million in partial scholarships for children living in the inner city of Boston and attending Catholic schools.

Mr. Lynch is also the recipient of many professional awards. He was recognized in the Business Hall of Fame of both Fortune magazine and the television show Wall Street Week.