With chapter six, Peter Lynch has reached the "Picking Winners" section of "One Up on Wall Street." Readers are off to a fast start: Lynch is already talking about 10-baggers, which is to say, stocks that will experience a 10-fold increase in value over some unspecified time period.
He reminded us that many of the 10-baggers of his time, including L’eggs (HBI, Financial), Dunkin’ Donuts (DNKN, Financial) and Subaru (TSE:9778, Financial), first manifested themselves as great products rather than stocks.
He singled out Pep Boys (PBY, Financial) to illustrate his case, observing that many people would have been aware of the company’s success: executives, clerks, lawyers, accountants, suppliers, advertising providers, building contractors for new stores and even the people who washed the floors. Beyond Pep Boys directly, the staff buying insurance would have insightful information about the insurance cycle and contractors pouring cement for new Pep Boys’ buildings would be aware of the cement pricing cycle. What’s more:
“You don’t have to be a vice president at Exxon to sense the growing prosperity in that company, or a turnaround in oil prices. You can be a roustabout, a geologist, a driller, a supplier, a gas-station owner, a grease monkey, or even a client at the gas pumps.“
In other words, opportunities exist everywhere if we are open to seeing them. Everyone consumes something, and each time we come across an outstanding product, we should ask this Lynch question: “Who makes this gizmo?”
“So often we struggle to pick a winning stock, when all the while a winning stock has been struggling to pick us.”
Everyone included
Lynch asked us to imagine a hermit-like existence in the middle of nowhere, where you grow your own food and don’t have a television set. Would that leave you with knowledge you could apply to finding 10-baggers?
“Well, maybe one day you have to go to a doctor. The rural existence has given you ulcers, which is the perfect introduction to SmithKline Beckman.”
This is the company that developed Tagamet, and a great investor’s drug because the patient must keep buying it (on the other hand, Lynch said, a great patient’s drug is one that cures with one-time use). There were other drugs, too, that gained their companies multi-bagger status, including Zantac. He rhetorically asks, “Did the doctors who prescribed Tagamet and Zantac buy shares in SmithKline and Glaxo?
“Somehow I doubt that many did. It’s more likely that the doctors were fully invested in oil stocks. Perhaps they heard that Union Oil of California was a takeover candidate. Meanwhile, the Union Oil executives were probably buying drug stocks, especially the hot issues like American Surgery Centers, which sold for $18.50 in 1982 and fell to 5 cents.”
Lynch emphasized this point: oil experts are in a better position than doctors, on average, to know when to buy and sell Schlumberger (SLB, Financial), and doctors generally should know better than oil experts when to invest in drug companies.
Two types of advantages
So far, Lynch had listed advantages that non-professional investors have over the pros. But, he had not finished with that. He also argued for the existence of two kinds of amateur investors: (1) professional knowledge about industries and (2) a “grassroots observer’s” awareness of exceptional products.
For example, he cited the case of someone who works in a cyclical industry. That person will know where prices are headed, at least temporarily, and perhaps knows whether new competitors are entering the industry, along with the knowledge it takes at least two years to build a new plant. Collectively, those pieces of information provide very useful insights about pricing and competitive moats.
Lynch also believed the grassroots observer could recognize a turnaround in an industry six to 12 months before a regular financial analyst. This provides an “incredible head start” in anticipation of an improvement (or deterioration) in earnings for someone who works within that industry. Whether it is the professional or grassroots edge you enjoy, it will help you pick winners:
“Whichever edge applies, the exciting part is that you can develop your own stock detection system outside the normal channels of Wall Street, where you’ll always get the news late.”
Lynch’s “wonderful” edge
At the time Lynch was finishing "One Up on Wall Street," he was looking back at his own failures to practice what he preached. He was right in the middle of the financial industry, where he had been active for nearly 20 years, had an extensive network of contacts in the industry and followed the daily ups and downs. In fact, he wrote, he could see important trends months before the analysts on Wall Street.
Yet, he confessed he bought “not a single share of any of the financial services companies” while the industry was madly going up. His fund could not invest in Fidelity Investments, where he worked, because it was not a public company; but other fund companies—Dreyfus, Federated and Franklin—were public and available:
- Dreyfus (now part of Bank of New York Mellon (BK, Financial)) was a 100-bagger between 1977 and 1986.
- Franklin (now Franklin Templeton Investments) delivered a 138-bagger.
- Federated was a 50-bagger before being acquired by another company.
Lynch ruefully admits:
“I missed the whole deal and didn’t realize it until it was too late. I guess I was too busy thinking about Union Oil of California, just like the doctors."
“Every time I look at the Dreyfus chart, it reminds me of the advice I’ve been trying to give you all along: Invest in things you know about. Neither of us should let an opportunity like this one pass us by again, and I didn’t. The 1987 market break gave me another chance with Dreyfus.” [he will discuss Dreyfus again in Chapter 17]
Conclusion
Lynch candidly admitted his missed opportunities in chapter six; easier to do, of course, when you have an average annual return of better than 29% and a multibillion-dollar portfolio.
At the same time, he appeared to encourage hesitant investors, seemingly saying to them that they know more than they think, and in that they have an edge over the professionals. Yes, you will make mistakes, but if you use what you know, you can stalk the 10-baggers too.
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.)
