In an interview he gave to PBS, Peter Lynch discussed what is needed to achieve a track record similar to his. Even though the answer seems simple on the surface, it has many insights that are worth commenting on.
Q: Was that your secret?
A: Well, I think the secret is, if you have a lot of stocks, some will do mediocre, some will do OK, and if one or two of 'em go up big time, you produce a fabulous result. And I think that's the promise to some people. Some stocks go up 20% to 30%, and they get rid of it, and they hold on to the dogs. And it's sort of like watering the weeds and cutting out the flowers. You want to let the winners run. When the fun ones get better, add to 'em, and that one winner, you basically see a few stocks in your lifetime, that's all you need. I mean stocks are out there. When I ran Magellan, I wrote a book. I think I listed over 100 stocks that went up over tenfold when I ran Magellan, and I owned thousands of stocks. I owned none of these stocks. I missed every one of these stocks that went up over tenfold. I didn't own a share of them. And I still managed to do well with Magellan. So there's lots of stocks out there and all you need is a few of 'em. So that's been my philosophy. You have to let the big ones make up for your mistakes.
In this business, if you're good, you're right six times out of 10. You're never going to be right nine times out of 10. This is not like pure science where you go, "Aha," and you've got the answer. By the time you've got "Aha," Chrysler's already quadrupled or Boeing's (BA, Financial) quadrupled. You have to take a little bit of risk.
These are the points that are worth revisiting:
He had a wide range of outcomes. While it is common to think that great investors do not make mistakes, the reality is they also have blunders. They learn from them and, most importantly, make up for the losses with a few home runs. If you have a stock that goes up tenfold, then the available space to make some mistakes increases. (Not that I encourage it, but flexibility increases.) As he mentions, a big winner can make up for many losses.
Let your winners run. Generally,when we start winning, we get satisfied with our 20% to 30% return. However, if we take the time to look at the fundamentals and nothing has changed, or better yet, they have improved, then the best and most rational thing to do is to let those winners run. The emotional bias we are trying to avoid here is called loss aversion.
Be willing to take a little risk. Whenever we run across an interesting story, and at an attractive point, Lynch encourages us to take the dive and be willing to bet on that story early, as that is the way to get the most benefits. This is not contrary to the views of a value investor, as he tends to look where others don't. Charlie Munger (Trades, Portfolio) has suggested that, if he had to do it all over again, he would probably look at micro and small caps in order to reap similar results.
What do you think?
