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Robert Abbott
Robert Abbott
Articles (811)  | Author's Website |

‘One Up On Wall Street’: Chapter 2 Reviewed

Amateur investors really can outdo professional investors and fund managers. Peter Lynch explains why

July 16, 2018 | About:

In the first sentence of the first chapter of his best-selling book, “One Up On Wall Street”, Peter Lynch began with these words, “There’s no such thing as a hereditary knack for picking stocks.”

In the second chapter, titled “The Wall Street Oxymorons,” he approached this issue from the other side and told us “To the list of famous oxymorons…I’d add professional investing.” Amateurs should look at professionals with a “skeptical eye.”

Getting more specific, he said institutional investors control 70% of shares in big companies. That’s a lucky break for us, he added, because the professional investors in these institutions are restrained by many cultural, legal and social barriers.

There are exceptions to the professional investor oxymoron, and he points to a couple of “innovative fund managers” and “maverick fund managers” who do as they please and do exceptionally well:

  • John Templeton, a global fund manager, one of the first, according to Lynch, to make money all around the world.
  • Max Heine of Mutual Shares and his protégé Michael Price (Trades, Portfolio); they succeeded by buying asset-rich companies for fifty cents on the dollar and holding until the market recognized their full value.

However, the exceptional managers are:

“...entirely outnumbered by the run-of-the-mill fund managers, dull fund managers, comatose fund managers, sycophantic fund managers, timid fund managers, plus other assorted camp followers, fuddy-duddies, and copycats hemmed in by the rules.”

Or, to put it more politely, there is a groupthink contagion that hems in most fund managers because they all read the same papers and magazines and listen to the same economists.

Everyone waits

Lynch says he has found some spectacular stocks, potential 10-baggers so appealing that 99 out of 100 investors would buy them if they could, but they could not. No stock can possibly be attractive to most professionals until it has been acquired by many institutions and many respected Wall Street analysts. Everyone is waiting for everyone else. By way of proof, he cites these examples:

  • The Limited (now private): One of Lynch’s favorites, it went public in 1969 but was not picked up by an institution until 1975, and by 1979 there were only two. Most stock was owned by employees and managers, and it wasn’t until 1985 that analysts began giving it attention.
  • Service Corp. International (NYSE:SCI): Another favorite, this funeral home aggregator went public in 1969 and “Not a single analyst paid the slightest heed for the next 10 years!”
  • Subaru Corp. American depositary receipts (FUJHY) and Dunkin Donuts (NASDAQ:DNKN), referenced in chapter one, were mostly ignored by Wall Street while they were making impressive inroads into their respective markets.

The CYA syndrome

In Lynch’s opinion, professionals don’t invest to make big profits, they invest to avoid losses:

“Whoever imagines that the average Wall Street professional is looking for reasons to buy exciting stocks hasn’t spent much time on Wall Street. The fund manager most likely is looking for reasons not to buy exciting stocks, so that he can offer the proper excuses if those exciting stocks happen to go up.” And, “Success is one thing, but it’s more important not to look bad if you fail.”

Lynch said he was fortunate not having to be caught in those handcuffs, those that constrain managers who pick stocks for other professionals. While “shareholders” in the Magellan fund are smaller investors and can sell at any time, they do not go over his portfolio one stock at a time and second-guess his decisions.

Professionals and plodders

Continuing his exposition to emphasize that amateurs can beat the professionals, Lynch turns to regulations and rules constraining the professionals.

Individual banks or pension funds often have rules for their stock pickers. For example, investing only in non-growth industries or industries in certain sectors. As Lynch caustically observes:

“Sometimes it gets to the point that the fund manager can’t buy shares in any company whose name begins with r, or perhaps the shares must be acquired only in months that have an r in their name, a rule that’s been borrowed from the eating of oysters.”

Then, there are rules stipulated by the Securities and Exchange Commission. Lynch was affected by SEC rules saying mutual funds could not own more than 10% of shares in any one company, and no more than 5% of the fund’s capital could go into any one stock.

He acknowledges the restrictions are well intentioned and provide some protection. They can severely restrict the size of returns, however, by restricting the choices available. Bigger funds, for example, end up having to choose from the top 90 to 100 companies, and were forced to ignore the more than 9,000 stocks available at that time.

Then, there are market cap limitations imposed by some fund companies and institutions: stocks below a certain market capitalization could not be selected or stocks below a certain dollar value (such as $5 or $10) could not be purchased.

The result, then, was not encouraging for those seeking multibaggers:

“By definition, then, the pension portfolios are wedded to the ten-percent gainers, the plodders, and the regular Fortune 500 bigshots that offer few pleasant surprises.”

The chafing point for Lynch is the size of his fund, “The bigger the equity fund, the harder it gets for it to outperform the competition.” Still, he said he could compete successfully despite the Magellan fund’s size:

“The stocks I try to buy are the very stocks that traditional fund managers try to overlook. In other words, I continue to think like an amateur as frequently as possible.” (author’s emphasis)

Conclusion

Lynch wound up the chapter with a couple of important conclusions:

  • “You don’t have to invest like an institution. If you invest like an institution, you’re doomed to perform like one, which in many cases isn’t very well.”
  • Amateur investors need not report to anyone higher up (except perhaps to spouses) and need not spend a quarter of their time justifying why they bought, what they bought, or the price they paid. Also:

“Most important, you can find terrific opportunities in the neighborhood or at the workplace, months or even years before the news has reached the analysts and the fund managers they advise.”

Finally, he prepares us for the upcoming chapter with these words:

“Then again, maybe you shouldn’t have anything to do with the stock market, ever. That’s an issue worth discussing in some detail, because the stock market demands conviction as surely as it victimizes the unconvinced.”

GuruFocus provides the Peter Lynch Screener 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”; 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.)

About the author:

Robert Abbott
Robert F. Abbott has been investing his family’s accounts since 1995 and in 2010 added options -- mainly covered calls and collars with long stocks.

He is a freelance writer, and his projects include a website that provides information for new and intermediate-level mutual fund investors (whatisamutualfund.com).

As a writer and publisher, Abbott also explores how the middle class has come to own big business through pension funds and mutual funds, what management guru Peter Drucker called the "unseen revolution."

Visit Robert Abbott's Website


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