Selected Materials from Book - Beating the Street by Peter Lynch

Transfer from my old blog

Beating the Street by Peter Lynch December 12, 2007 5 out 5

Peter Lynch is known as one of the top mutual fund manager in the country. He began managing the Fidelity Magellan fund from 1977, an $18 million fund with $50 million tax-loss carryforward, to a $12 billion fund when he retired from it in 1990. In this book, he talked about general strategies, his managements at Magellan, and analyzed a few specific stocks that held his interests.

Here is a story he told at end of his preface: a genie grants a farmer a wish that he can keep all the land he can encircle on foot on this day. So started running and circle valuable properties and more and more land thinking the more he can acquire the more for his family and progeny to thrive on. So he didn’t stop, but the poor farmer in the end died of exhaustion.

100% allocation in stocks grows faster than other equity investments in long term. If you remain in long-term and do not pull out during corrections.

Broker’s biggest commission are made from mutual fund, underwritings, and options.

He dedicated a whole chapter on the performance of the students from St. Agnes grade school from Arlington Mass and NAIC, a organization of 1000 or more amateur investment clubs, both outperform S&P500 and tops the returns from most of professionals.

Lynch suggested rule of 5: owning 5 stocks.

He commented people sells more when they have more time to think which translate to worry. This maybe the reason why, historically Mondays and Decembers are biggest down days.

Within past 70 years (from 1993?) there were 40 declines of 10% or more and 13 of which are 33% declines.

1929-33 Depression, 1987 Great Correction, 1990 Saddam sell-off.

There are about 3565 funds, 1266 equity fund, 1457 bond and income funds, 566 taxable money market funds, and 276 short-term municipal funds. Possible growth of more funds than stocks. He talked about some different categories of funds include: capital appreciation funds, value funds, quality growth funds, emerging growth fund, special situation funds, sector fund, convertible funds, closed-end funds, and country funds.

SP500 made up of corporate giants in drug and food business. Dow Jone has many cyclical companies, and NASDAQ and Russell 200 represent growth companies.

Follow the progress of T Rowe Price New Horizons to decide when to invest in growth funds. The New Horizon P/E to SP500 P/E ratio violates from 1.0 to 2.0. Avoid Growth when this ratio approach 2.0. Each cycle (from 1.0 to 2.0 to 1.0) can last more than 5 to 10 years.

Fidelity offered the first sector fund in 1981.

Buy convertible funds when the spread between convertible and corporate bonds and narrow within 2%.

Buy Closed-end fund when the equities in a closed-end fund falls below the equity of the companies held in the closed-end fund.

Treasure > bond fund.

Lynch selected his company based on his own homework, go directly to the primary source, meet and talk to CEOs, ask each which competitor they respect the most, identify possible candidates from analysts and fund managers.

Lynch: “There may be fewer liars on Wall Street than on Main Street.” Because soon or later financial results are published which would effect their credentials.

Must be able to explain what the company do in simply language before any investments.

Avoid bad information, “A hostile reception might not affect your confidence immediately, but the brain never forgets a painful experience.”

Rule of 72: If earning increase 20% annual, then 2x in 3.5 years and 4x in 7 years. Divide annual return into 72, the result is number of year it takes to double the money.

Tech company are risky and may lose value dramatically when rival unveil better product.

”When you concern with what person behind you thinks about your work, it seems to me that you cease to be a professional. You are no longer responsible for what you do.”

Everyone is watching everyone on Wall Street.

When interest rate are high, they will come down soon or later, the correspondingly, stocks and long-term bond would profit.

Usually, cyclical stock lead the market at end of a recession. In case of 1987 Correction, the winning stocks turn out to be growth stock not cyclical. Cyclical include papers, chemicals, steels. “Cyclical are like blackjacks: stay in the game too long and it’s bound to take back all your profit.”

Lynch divided Magellan portfolio into two parts: growth and cyclical stocks and conservative stocks. Like how Graham suggest stock to bond ratio. And adjust this ratio based on the current market. Lynch substituted conservative stocks for bonds.

Lynch suggested a fear hours a year is needed to keep up with one company.

”Investment seminars are greatest laborsaving device for fund managers ever invented.”

Presentations can offer exposures to many great companies.

”The best stock to buy may be the one you already own.”

”One of the clues to the bank’s deep trouble was the behavior of its bonds.” “Before you invest in a low-priced stock in a shaky company, look at what’s been happening to the price of the bonds.”

”Stockpicking is both an art and a science, but too much of either is a dangerous game.”

”you could make a nice living buying stocks from the low list in November and December during the tax-selling period and then holding them through January, when the prices always seem to rebound. This January effect, as it’s called, is especially powerful with smaller companies.”

The managers of retails are greatest source of information, since they have access to the monthly sales figures.

”in double-decker malls, the most popular retailers are usually found upstairs.”

Avoid retailers that expand too fast on borrowed money.

P/E 40x are dangerous, 25x consider high for most growth company.

”A technique that works repeatedly is to wait until the prevailing opinion about a certain industry is that things have gone from bad to worse, and then buy shares in the strongest companies in that group.”

Goodwill on balance sheet is the amount that have been paid in an acquisition above and beyond the book value.

Lynch suggested equity to debit ratio of above 2x. When company claims to cut cost, verify it by check in S, G, A (selling, general, and admin. Expenses).

when housing crashes, the banking systems goes along with it.

take advantage of S&L during IPO. Pg 216.

Cyclical: “When the economy is in the doldrums, the professional money manager begin to think about investing in the cyclical. The raise and fall of the aluminums, steels, paper products, auto manufacturers, chemicals, and airlines from boom to recession and back again is a well-known pattern, as reliable as the seasons.” Conversely than normal, high p/e may be good news for cyclical (expectation of getting ready to take off).

Aluminum is abundant in earth crust, about 8%. Copper is scarcer and depletes.

Lynch go through several examples of how to value a company based on growth. One on pg238 on Phelps Dodge, now FCX, base on copper productions.

Used-cars prices is useful indicator for auto stocks. Direct relationship. “After four or five years when sales are under the trend, it takes another four or five years of sales above the trend before the car market can catch up to itself.”

Treat utilities as interest-rate cyclical.

Company that changes name are bad sign, want to people to forget the fiascoes.

When government privatize companies, it’s usually good for the buyers.

Lynch was long-term proponent of Fannie Mae. Dedicated a whole chapter on Fannie Mae.

He summaries his life long experience into 25 golden rules at end of the book. Most are general but here I quote one.

”With small companies, you’re better off to wait until they turn a profit before you invest.”