Some things we just can’t avoid. For Peter Lynch, a public speaker and the author of “One Up on Wall Street,” it was the inevitable question after every presentation he gave. Someone would ask if the market was good or if the market was bad:
“I always tell them the only thing I know about predicting markets is that every time I get promoted, the market goes down. As soon as those words are launched from my lips, somebody else stands up and asks me when I’m due for another promotion.”
He was, indeed, not a seer, predictor or forecaster. As Lynch reported, every major up and down in the market has come as a surprise to him. Nor is he alone. Many people told him after the fact that they had expected the boom or the bust, but no one mentioned it to him before the fact.
Preparing for the past
In The Military Engineer magazine for January-February 1929, Lieutenant Colonel J. L. Schley wrote, “It has been said critically that there is a tendency in many armies to spend the peace time studying how to fight the last war.”
Lynch had the same feeling about investors: “We always seem to be preparing ourselves for the last thing that’s happened, as opposed to what’s going to happen next.” He calls this the “penultimate preparedness” and said it explained the fact that we did not see the last thing coming.
Ironically, he noted, “Those who got out of the market to ensure that they wouldn’t be fooled the next time as they had been the last time were fooled again as the market went up.”
The Lynch cocktail theory
Although eschewing all forecasting, he had a theory about amateur investors. He called it the "cocktail theory," based on spending time at many cocktail parties where he listened to what the 10 closest people said about stocks. There are four stages, he argued:
- Stage 1: When people ask him what he does, and he explains he manages a mutual fund, “they nod politely and wander away,” and “Soon they are talking to a nearby dentist about plaque.” Lynch said that when people would rather talk about plaque, odds are it means the market is about to head up.
- Stage 2: People now stick around a bit longer and tell him how risky it is to invest in stocks before going on to talk to the dentist. This means the market is up 15% but no one is paying attention.
- Stage 3: Now they ignore the dentist and cluster around Lynch, and everyone — including the dentist — are asking what stocks they should buy. They’ve now all invested in the market.
- Stage 4: Again, they crowd around him, but now they’re telling him what stocks he should buy. Once the dentist and neighbors have given their advice, and he wishes he had taken their advice, he knows the market has peaked and will soon slump.
Nevertheless, Lynch didn’t buy or sell according to the cocktail theory:
“I don’t believe in predicting markets. I believe in buying great companies — especially companies that are undervalued, and/or underappreciated.”
Like Warren Buffett (Trades, Portfolio), he believed the market should be irrelevant. “If I could convince you of this one thing, I’d feel this book had done its job,” he said. He went on to cite Buffett’s famous words:
“As far as I’m concerned, the stock market doesn’t exist. It is there only as a reference to see if anybody is offering to do anything foolish.”
Lynch was, and probably still is, a great admirer of Buffett, noting that an investor who invested $2,000 in Berkshire Hathaway (BRK.A, Financial)(BRK.B) in the early 1960s at $7 per share would have had an investment worth $1.4 million in 1988, a 700-bagger. Imagine what he must think now, in 2018, with Berkshire A-shares trading at $303,210 compared to roughly $4,900 in 1988.
His admiration was not restricted to just financial performance:
“What makes him the greatest investor of all time is that during a certain period when he thought stocks were grossly overpriced, he sold everything and returned all the money to his partners at a sizable profit to them. The voluntary returning of money that others would gladly pay you to continue to manage is, in my experience, unique in the history of finance.”
The futility of predictions
Lynch posed the argument that even if you could predict the next economic boom, with absolute certainty, you would still have to pick the right stocks. That would be the same as not being able to predict with certainty.
For example, if you knew the computer business was booming, and you bought Fortune Systems to cash in — without doing any homework — you would have soon found yourself much poorer. It fell from $22 in 1983 to $1.82 in 1984.
If you saw the boom for airlines in the early 1980s, it would not have helped if you bought People Express (soon bankrupt) or Pan Am which lost more than 50% of its value in one year because of “inept” management.
Lynch’s recommendation is to watch valuations. “The way you’ll know when the market is overvalued is when you can’t find a single company that’s reasonably priced or that meets your other criteria for investment,” he said.
Conclusion
In this last chapter of the “preparing to invest” section of “One Up on Wall Street,” Peter Lynch took on the human propensity to predict, or speculate, about the future of markets, stocks and even the whole economy. To him, it is a waste of time:
- Preparing for the future based on predictions is as ineffective as the military preparing for the last war.
- When the people you meet are disinterested in stocks, it means a bull market is arriving. Similarly, when everyone is offering stock tips, the bear is lurking.
Quite simply, all forecasting and predicting is useless. Instead, he believed in buying great companies that are undervalued or underappreciated.
With that, Lynch finished the preparation section, and was ready to tell readers about the art and science of picking stocks.
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.
