Peter Lynch has an amazing investment record. During his 13 years of managing the Magellan Fund at Fidelity Investments, he brought in average annual returns of more than 29%. His successes brought new respect and popularity for mutual funds, vast inflows to his fund and his first book about investing was a best seller.
“One Up On Wall Street: How to Use What You Already Know to Make Money in the Market” was co-written with John Rothchild and first published in 1988. Since then, there have been numerous editions and reprintings.
As the title suggests, this is primarily a book for non-professional investors and it suggests a competitive advantage for them, thanks to familiarity with how consumers respond to new products and services. Lynch also called it, “The Advantages of Dumb Money” and “The Power of Common Knowledge.”
His most prominent example was L’eggs, women’s hosiery; Lynch called it “one of the two most successful consumer products of the seventies.” In addition, it was discovered by his wife Carolyn, not him:
“I knew the textile business from having traveled the country visiting textile plants, calculating profit margins, price/earnings ratios, and the esoterica of warps and woofs. But none of this information was as valuable as Carolyn’s. I didn’t find L’eggs in my research, she found it by going to the grocery store.”
Prologue
Lynch began his book with an account of a holiday in Ireland, a visit that coincided with a dramatic week in the markets: the October 1987 crash. With humor and perspective, he first told us about the holiday and golfing. That was followed with another layer: what he was thinking and doing during this crisis, and as it turned out his mind wasn’t much on golfing or the scenery.
Instead, he was on the phone with his colleagues back in Boston as they worked out what to sell to meet a rash of redemptions in his fund. Lynch confessed he let the desperate days get to him; fortunately, his clients were more restrained. He reported fewer than 3% of his account holders exited the fund and said, “When you sell in desperation, you always sell cheap.”
Better than the average Wall Street expert
From the start of the introduction, Lynch wanted readers to believe that they too could invest successfully:
“any normal person using the customary three percent of the brain can picks stocks just as well, if not better, than the average Wall Street expert.”
While he was giving readers advice about investing in stocks, he still saw a prominent place for mutual funds, calling them a “wonderful invention” for those who do not have the time, inclination or enough money for suitable diversification. Benjamin Graham would have called these people defensive investors, while enterprising investors would be those who want to use Lynch’s ideas to earn above-average returns.
An American consumer with a credit card, he said, is someone who has already done a lot of fundamental analysis on many companies. Fortunately, this kind of research often turns up “tenbaggers.”
Tenbaggers
Throughout Lynch’s writing, we often encounter the “baggers.” “Tenbagger” means a stock that has grown 10-fold since being purchased; a “hundredbagger” is one that has grown 100-fold. He said he became addicted to such stocks because the first one he bought became a multibagger and paid his way through graduate school.
Lynch also wanted to disabuse readers of the idea that a 10-bagger could only come from a penny stock that caught fire. Instead, 10-baggers can emerge from anywhere, and he offers the example of Subaru Corp. An investor who bought this Japanese carmaker at its low in 1977 and sold at the high in 1986 would have scored a 156-bagger. There were other 10-baggers on his mind when he published this book in the late 1980s, including Dunkin’ Donuts (DNKN, Financial), Walmart (WMT, Financial) and the now bankrupt Toys 'R' Us.
The power of common knowledge
Hitting the lows and highs is not necessary to this exercise; simply buy familiar companies with good businesses. Lynch became interested in Yum Brands' (YUM, Financial) Taco Bell after eating a burrito while on a road trip; La Quinta (LQ, Financial) also came to his attention during a trip; many of his friends and family drove Volvos (OSTO:VOLV B), his children owned an Apple (AAPL, Financial) computer, which at that time was still relatively new. In all these companies he had seen quality products and services, and that lead to serious financial research.
After hearing about L’eggs from his wife, he began researching it in his office. What he discovered was the parent company, which is now Hanesbrands Inc. (HBI, Financial), was testing the sale of panty hose in grocery stores, whereas other companies sold them only in department and specialty stores (even Hanes had stuck to those retail channels before testing L’eggs). Research showed women visited department or specialty stores once every six weeks, while they visited grocery stores twice a week. That gave L’eggs 12 times as many opportunities to be discovered and bought—and the idea worked very well.
Lynch goes on to emphasize investors did not have to know L’eggs as soon as the product came out. Even investors who bought in the third year after L’eggs went nationwide could have scored at least three-baggers.
Familiarity does not necessarily breed contempt
A couple of points arise out of this strategy of buying what you know. Lynch said:
“During a lifetime of buying cars or cameras, you develop a sense of what’s good and what’s bad, what sells and what doesn’t.”
Consider a couple of examples from the world of Warren Buffett (Trades, Portfolio) and Charlie Munger (Trades, Portfolio):
- Buffett discussed the research he and Charlie Munger (Trades, Portfolio) used in the acquisition of Dairy Queen. “Charlie and I bring a modicum of product expertise to this transaction. He has been patronizing the Dairy Queens in Cass Lake and Bemidji, Minnesota for decades, and I have been a regular in Omaha.”
- And Buffett said he liked Apple, in part, because, ““When I take a dozen kids, as I do on Sundays, out to Dairy Queen, they’re all holding their [iPhones]” Buffett told CNBC. “They barely can talk to me except if I’m ordering ice cream or something like that.”
Still, knowing there is a good product on the street doesn’t necessarily mean the stock will be a winner. You can’t go out and buy every new franchise and expect success:
“If it were that simple, I wouldn’t have lost money on Bildner’s, the yuppie 7-Eleven right across the street from my office. If only I’d stuck to the sandwiches and not to the stock, fifty shares of which would scarcely buy you a tuna on rye.”
And then there was Coleco: “Just because the Cabbage Patch doll was the best-selling toy of this century, it couldn’t save a mediocre company with a bad balance sheet.”
It’s never too late
Regrets are not confined to buying the bad businesses behind successful products and services. There was also regret about missing the big successes.
Lynch observed, however, that there were enough 10-baggers available that we could miss the majority but still get our share. And small investors had an edge over Lynch and the Magellan fund: he had to find many 10-baggers to make a material difference in his giant fund, whereas small investors only have to score one.
Taking that thought a step further, Lynch winds up the introduction by saying:
“All my failures notwithstanding, during the twelve years I’ve managed Fidelity Magellan, it has risen over twentyfold per share—partly thanks to some of the little-known and out-of-favor stocks I’ve been able to discover and then research on my own. I’m confident that any investor can benefit from the same tactics. It doesn’t take much to outsmart the smart money, which, as I’ve said, isn’t always very smart.”
Conclusion
In the prologue and introduction to “One Up on Wall Street," Lynch sets high expectations. Investors need not be expert analysts to realize those expectations.
In discussing the potential value of overlooked and out-of-favor stocks, Lynch tells us he has a foot firmly planted in the value camp while at the same time pursuing growth stocks.
In outlining the chapters ahead, he said the first section (chapters one through five) would focus on preparing to invest. The second section (chapters six through 13) would address the issue of finding winners, and the third section would address the long-term view.
For those who want to search for stocks in the Lynch way, GuruFocus provides a Peter Lynch screener, which provides lists of stocks that meet his essential criteria. Members can access the screener here, and non-members can get started here.
Disclosure: I do not own shares in any company listed, and do not expect to buy any in the next 72 hours.
This review is based on the Millennium Edition (2000) of “One Up On Wall Street”; by the time this edition appeared, the book had already sold more than a million copies.More of these chapter-by-chapter reviews can be found here.
