“We’ve made great advances in eliminating ignorance and superstition in medicine and in weather reports, we laugh at our ancestors for blaming bad harvests on corn gods, and we wonder, 'How could a smart man like Pythagoras think that evil spirits hide in rumpled bedsheets?' However, we’re perfectly willing to believe that who wins the Super Bowl might have something to do with stock prices.”
With those words, Peter Lynch launched into chapter 18 of "One Up on Wall Street," a chapter in which he tackles what he calls “The Twelve Silliest (and Most Dangerous) Things People Say About Stock Prices."
“If it’s gone down this much already, it can’t go much lower”
How many times have we all heard that gem? Like many of us, Lynch too fell for that siren song and reported learning how wrong this advice could be the hard way. Early in his tenure at Fidelity Investments, he recommended Kaiser Industries to his colleagues when it was selling at $11 (at that time, Kaiser was a conglomerate with multiple product lines, including real estate, aluminum, shipbuilding, broadcasting and jeeps). Fidelity then bought 5 million shares.
Buoyed by what he believed was a strong balance sheet, he was sure Kaiser could not go below $10, but, of course, it did, falling all the way down to $4, where it finally stopped. Fortunately, his colleagues did not panic and a few years later it rebounded to $30 per share. But, the event scared Lynch enough to cure him of that advice.
“You can always tell when a stock’s hit bottom”
Along the same lines is the practice of buying a falling stock, which Lynch likened to catching a falling knife; “Grabbing a rapidly falling stock results in painful surprises, because inevitably you grab it in the wrong place.” He argues investors should wait until the knife hits the ground, sticks there and vibrates for a while before jumping in.
He also liked fundamental reasons for jumping into this kind of turnaround; for example, the balance sheet shows $11 per share in cash while the stock sells for just $14.
“If it’s gone this high already, how can it possibly go higher?”
The essential point here is there is “no arbitrary limit” to the heights a stock can reach, assuming the story line continues, earnings are improving and the fundamentals remain strong. For Lynch, his experience with Philip Morris (PM, Financial) and Subaru clearly made the case.
He said Philip Morris shares were available for the equivalent of 75 cents per share and, as the share price kept rising, there were many points at which investors could and did bail out, asking “How can it possibly go higher?” By the time this book was published in 1988, it had risen to $124.50—more than a 100-bagger in those 30 years—as well as having thrown off $23,000 in dividends. A year later, in 1989, the stock was close to $180 per share and underwent a four-for-one stock split.
“It’s only $3 a share: What can I lose?”
With an eye to minimizing potential losses, some investors look for low-priced stocks. Lynch disagreed, saying “I put in twenty years in the business before it finally dawned on me that whether a stock costs $50 a share or $1 a share, if it goes to zero you still lose everything.” He added, “The point is that a lousy cheap stock is just as risky as a lousy expensive stock if it goes down.”
“Eventually they always come back”
At the time Lynch wrote this book in the mid-1980s, investors had been waiting 65 years for RCA to make a comeback, despite its original success. And it wasn’t the only one:
“When you consider the thousands of bankrupt companies, plus the solvent companies that never regain their former prosperity, plus the companies that get bought out at prices that are far below the all-time highs, you can begin to see the weakness in the 'they always come back' argument.”
“It’s always darkest before the dawn”
Here, Lynch rebutted what he calls a human tendency to believe that while some things have gone a little bad, they can’t get any worse. His examples include the oil drilling industry in the 1980s. More than 4,500 rigs were active in 1981, but declined to about half that number by 1984 as the oil price slump continued. Some investors jumped in at that point, thinking the worst was over. However, by 1986, there were fewer than 700 active rigs.
“Sometimes it’s always darkest before the dawn, but then again, other times it’s always darkest before pitch black.”
“When it rebounds to $10, I’ll sell”
The guru said his experience had been that downtrodden stocks never return to the level at which you decided to sell. That’s not just a simple wasted opportunity; it can also tie up your money when it should be earning for you.
Lynch came up with a good test to counter this business of holding until the fallen stock clawed its way back up to your target price: “I remind myself that unless I’m confident enough in the company to buy more shares, I ought to be selling immediately.”
“What me worry? Conservative stocks don’t fluctuate much”
According to Lynch, two generations of conservative investors bought utility stocks, believing these were safe stocks that did not require monitoring. But by the time of the Lynch years, the late 1970s to late 1980s, these once-safe stocks had been buffeted by nuclear problems and rate-base problems. Consolidated Edison (ED, Financial) was down more than 80% at one point, only to suddenly recover and gain back more than they had lost.
“Companies are dynamic, and prospects change. There simply isn’t a stock you can own that you can afford to ignore.”
“It’s taking too long for anything to ever happen”
Lynch insightfully said, “where the fundamentals are promising, patience is often rewarded.” He lists a number of stocks that were seemingly stuck during his years at the helm of the Fidelity Magellan Fund. One was Merck (MRK, Financial), a stock with good fundamentals, so he was prepared to wait. Generally, he expected inactive stocks to make a move in their third or fourth year, but for Merck it was even longer. These stocks, which demanded patience, undoubtedly helped him earn an average of more than 29% per year during his fund management tenure.
“Look at all the money I’ve lost: I didn’t buy it!”
We’ve all had those regrets about roads not taken, about stocks not bought that went on to become multibaggers. Lynch warned investors, though, that:
“Regarding somebody else’s gains as you own personal losses is not a productive attitude for investing in the stock market. In fact, it can only lead to total madness.”
This fallacy can also lead investors to try to play catch up, and they end up suffering real losses as well as phantom losses.
“I missed that one, I’ll catch the next one”
Not so fast, said Lynch. Investors who chase the next big thing also can compound their problems:
“Actually you’ve taken a mistake that cost you nothing (remember, you didn’t lose anything by not buying Toys 'R' Us) and turned it into a mistake that cost you plenty.”
That is, of course, somewhat ironic from today’s perspective, given the recent bankruptcy and store-closings of Toys 'R' Us in the past year. Lynch said, “In most cases it’s better to buy the original good company at a high price than it is to jump on the “next one” at a bargain price.”
“The stock’s gone up so I must be right, or …The stock’s gone down so I must be wrong”
Don’t confuse prices with prospects, said Lynch. He was referring to investors who thought they had a winner when their stock increased a bit, but unless they were short-term traders, such gains meant “absolutely nothing.”
“A stock’s going up or down after you buy it only tells you that there was somebody who was willing to pay more—or less—for the identical merchandise.”
Conclusion
In chapter 18 of "One Up on Wall Street," Peter Lynch gave us a collection of fallacies to avoid.
Overall, though, I see it as a warning not to be lazy. That’s what every one of these sayings has in common: they’re providing shortcuts without substance.
Base your decisions on the fundamentals, not on the shortcuts. Decisions based on earnings, earnings growth, price-earnings ratios and other basics are of immensely more value than the cleverest shortcut in the investing universe.
GuruFocus provides the Peter Lynch screen tool for quickly finding companies that meet his criteria. Members can access the screener here, and non-members can get started here.
(This review is based on the Millennium Edition (2000) of “One Up on Wall Street.” More chapter-by-chapter reviews can be found here.)
Disclosure: I do not own shares in any company listed, and do not expect to buy any in the next 72 hours.
