Investment Greats: Peter Lynch

Published in Investing Strategy on 5 June 2009

Peter Lynch's management of the Fidelity Magellan Fund in the 1980s is legendary, but what are the secrets of his success?

He ran one of the most successful managed funds of the 1980s, and is held in great esteem by Motley Fool founder Tom Gardner, but what are the secrets to Peter Lynch's success?

Background

Born in 1944, Lynch grew up near Boston, Massachusetts. At the age of 11 he started caddying at the local golf course, and eventually started taking note of the stock tips he overheard as he worked. Although he had no money to invest, he became very aware of the money to be made in the bull market of the 1950s.

He won a scholarship to university, and combined with his ongoing work as a golf caddy, he was able to gather enough money together to buy his first share. Remarkably, this investment increased ten-fold, or to use the term that he later coined, became a 'ten-bagger'.

When he applied for an student job at Fidelity in 1966, there were 75 applicants for three positions, but having caddied for the President of the company for eight years he was a shoo-in for the job. "It was sort of a rigged deal, I think."

A stint in the army, followed by a master's degree from Wharton which was partly financed by that original ten-bagger, saw Lynch back at Fidelity as an analyst within a few years.

Fidelity, and the Magellan Fund

In 1977, at the age of 33, Lynch took over as manager of Fidelity's Magellan Fund, a growth-focused managed fund with a global remit, although in practice it was mostly concentrated in US stocks. With assets under management of $20m when he took over, the fund was worth $13bn by the time he retired, thirteen years later.

More importantly for investors, $1,000 invested at the start of his tenure would have grown to $28,000 during that time. It wasn't all plain sailing, though, as the fund lost a third of its value in two trading days during the crash of 1987.

During this time he wrote his best-known book, One Up On Wall Street.

Investment philosophy

Lynch is perhaps best known for encouraging investors to buy what they know, rather than investing in obscure or complicated ideas that they don't understand. "Never invest in any idea you can't illustrate with a crayon."

He believes a walk through the shopping mall can tell you a lot about the market, and that by simply living in the world and observing what's happening we already have a lot of information at our disposal. Consumption is research.

But we shouldn't be afraid to dig deeper before taking the plunge and investing. He finds it amazing that people will spend more time researching a holiday than they will researching an investment. "Investing without research in like playing poker without looking at the cards."

Critics have criticised this approach of investing in what you see around you, as many simple and understandable investment opportunities exist in other areas. A wide range of business-to-business firms will never be household names, but is it really better to overlook these in our search for mis-priced shares?

Perhaps surprisingly for an investor in growth businesses, Lynch has a liking for dull, slow-growth industries. A dominant player in a boring niche market is unlikely to face aggressive competition, and can probably maintain high margins. And if investment analysts have ignored it, that's another plus as it can probably be picked up more cheaply as a result.

A rule of thumb that Lynch uses to combine growth and value is to take the expected long-term growth rate -- plenty of scope for guesswork there, but however -- add the dividend yield, and divide the total by the price/earnings ratio (P/E). The observant among you will notice that this is basically the inverse of Jim Slater's PEG ratio, adjusted to account for dividend yield.

Don't time the market

Lynch doesn't attempt to time the market, but does take account of what people are talking about. When his neighbours are all discussing stocks, the market is probably a bit toppy. He is dismissive of attempts at forecasting, and pays little heed to the macroeconomics: "I've always said if you spend 13 minutes a year on economics, you've wasted 10 minutes."

In his quest for good investments, Lynch looks into as many companies as possible; it's a numbers game. "The person that turns over the most rocks wins the game. And that's always been my philosophy." And having done that, you're still going to get a considerable percentage wrong. "In this business if you're good, you're right six times out of ten. You're never going to be right nine times out of ten." Emotionally, you have to be able to handle that.

A key question for investors is what to do when the price falls after you've bought -- do you sell out while you can, or top up at a lower price? In contrast to Slater, who advises to cut losses, Lynch is more associated with the alternative strategy of 'averaging down', buying more at the lower price. But it's important to note that he's not mechanical about it, and has argued that "both strategies fail because they're tied to the current movement of the stock price as an indicator of the company's fundamental value".

"Investing in stocks is an art, not a science, and people who've been trained to rigidly quantify everything have a big disadvantage."

He's definitely on the same page as Buffett when he says "a share in a stock is not a lottery ticket. It's part ownership of a business."

Books by Peter Lynch:

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Comments

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RobinnBanks 10 Jun 2009 , 3:31pm

A very good article about one of my favourite investors. I have two of Peter's books, and they are well worth reading, but I still cannot emulate his ten-baggers! A three-bagger is my best so far, then it goes down again! And a few minus-baggers of course! How did he do it?

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