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Grahamites
Grahamites
Articles (301) 

Peter Lynch's 1987 Letter to Magellan's Shareholders

Excerpts of December 1987 OID

January 21, 2018 | About:

Peter Lynch is undoubtedly one of the best investors of all time. Most of us are familiar with his best selling book "One Up on Wall Street." However, there’s still very limited information about Lynch because he rarely gives interviews and talks. Thus, you can imagine the great joy I had when I bumped into Peter Lynch’s 1987 letter to Magellan’s shareholders from a very old OID issue. Below are excerpts of the letter from the December 1987 OID issue. I hope you'll enjoy.

Underperformance in bear markets:

There have been eight periods over the last decade when Magellan Fund has experienced a decline in share price ranging from 10% to 30%. In each of the past eight declines, Magellan’s share price has fallen more than the general market, and this pattern was true again in October’s steep drop.

The reason for Black Monday:

Stock markets move on the anticipation of events. In 1982 the advance began on the anticipation of an improvement in inflation, interest rates and corporate profits. The 1987 collapse was just the reverse. When the prime rate headed up, and the dollar began to fall sharply, investors began to worry about a recurrence of inflation and a recession in 1988. The seven week decline from August 1987 to October 19 caused several major participants in the market to reconsider their commitments to stocks. Individuals borrowing on margin had to sell to maintain their margin requirements. Foreign investors sold on fears of a further sharp decline in the dollar. Investment advisors told their customers to cut back or eliminated their stock holdings. Equity mutual fund redemptions added to the selling pressure. Portfolio insurance techniques used by large investors and pension funds in recent years, triggered heavy selling by these investors. Finally, program trading – simultaneous selling of market futures and individual securities, was a negative factor. In summary, as all these factors came together, a stock market that had rapidly advanced 1000 points in eleven months gave back the entire 1000 points in six weeks – with half of it in a single day.

No feeling for the direction of the market:

Over the next few months the market will quite volatile with substantial ups and downs If the market falls sharply again, Magellan will also have a major decline.I have no feeling for the direction of the market over the near term, or the next three to twelve months-and that has always been my position. All of the great advances and declines of the past twenty years have been surprises to me. However, I am optimistic about the next five to ten years.

Positives:

Baring a recession, which probably would last nine to twelve months, the outlook for corporate profits is excellent. Cost-cuting started in troubled industries such as automobiles and steel, but the effort now has spread to all forms of manufacturing such as fields as banking, transportation, health care, insurance, foods, retailing, and many others. Further cost savings are coming from enhanced productivity and firms are working very hard to improve the quality of their products and services with more emphasis on research and development. Prior to the sharp October decline in the market, the U.S. economy was really beginning to pick up steam. The improvement was led by a surge in industrial activity, which more than offset relatively restrained consumer spending on housing, autos and apparel. Third quarter GDP figures reflected some of the best gains in a long time.

Cost cutting + lower dollar = world class competition:

Many industries that have suffered depression conditions in the last three to five years such as metals, electronics, energy, energy services, and paper and forest products are improving. In many cases they have become world class competitors through a combination of cost-cutting and the lower dollar. Even if 1988 brings an economic downturn, American industry should be in a better position to weather the effects than it has been in the past because capacity has been reduced and expansions have been much more limited.

Stock purchases at unprecedented levels:

The market correction and the decline in the dollar have made American companies even more attractive for acquisitions by large foreign firms. Stock repurchasing by U.S. corporations, as well as individual purchases by their managers, is now at unprecedented levels.

Lower rates a plus:

The sharp drop in the stock market has been accompanied by a 10%-15% decline in interest rates – increasing the wealth of bond holders. Moreover, we have never had a recession in the last century without tight money or higher interest rates.

Budget deficits on the mend:

While the federal deficit is massive, it is being reduced; and we have seen a dramatic turn in the financial well-being of our state and local governments. Many of these had large deficits 10 years ago, but in some cases they are running surpluses now and beginning to reduce taxes.

Remarkable growth... likely to continue:

Finally, the American economy has continued its remarkable growth. There are over three million more people working today than a year ago. While the 500 largest corporates have reduced their payroll by over one million employees in the last decade, over 20 million more jobs have been created in the United States.

Political uncertainty potentially unsettling:

1988 will be the eighth and final year of President Reagan’s administration, and the anticipation of changes in government has had an unsettling effect on the stock market on several occasions in the past.

Buying quality companies which recent declined in price:

A sharp drop in the stock market is normally broad-based and affects all stocks. Many companies with excellent prospects, and industries which are not affected by economic changes, suffered sharp declines in price. We have been reducing our exposure to companies with uncertain outlooks or weak financial positions while purchasing companies with higher quality operations which have had similar price declines.

Magellan has greater upside and greater downside:

Megellan has always searched for opportunities within numerous industries. It has consistently been diversified among growth companies, special situations, value stocks and cyclicals. The fund has normally had between 20-35% in conservative stocks and bonds and 65-80% in more aggressive companies, where there is a greater risk of downside declines, but greater potentials for more substantial gain in price over time.

Megellan’s goal:

My goal is to outperform the market over the long term by 5-6% annually.

About the author:

Grahamites
A global value investor constantly seeking to acquire worldly wisdom. My investment philosophy has been inspired by Warren Buffett, Charlie Munger, Howard Marks, Chuck Akre, Li Lu, Zhang Lei and Peter Lynch.

Rating: 4.7/5 (9 votes)

Voters:

Comments

njsoxfan
Njsoxfan - 8 months ago    Report SPAM

You should correct the spelling of Magellan.

Grahamites
Grahamites premium member - 8 months ago

Njsoxfan - Thanks for pointing out my error. It's been corrected.

snowballbuilder
Snowballbuilder - 8 months ago    Report SPAM

"My goal is to outperform the market over the long term by 5-6% annually"

Not many manageres today even set the goal so high... They usually set mediocre goal that still they dont usually reach.

Thanks for sharing

Snow

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