As well as being a gifted investor, Peter Lynch has a knack for communicating important investing advice to his readers. In particular, he is good at summarizing investing dos and don’t with the help of personal anecdotes. In his book, "One Up On Wall Street," Lynch lists some misconceptions that amateur investors often have when starting out in the market.
“It’s gone down this much already, it can’t go any lower”
Many novice investors look at historical price levels for advice on where to buy and sell a stock. If the price approaches all-time lows, it can be easy to convince yourself that will be the lowest it can go. Even proper valuation techniques can lull you into a false sense of security - you run your calculations and decide that there’s a price below which a stock "cannot" trade. Of course, a stock can trade at any price, as Lynch himself learned early on in his career:
“There’s simply no rule that tells you how low a stock can go in principle. I learned this lesson for myself in 1971, when I was an eager but somewhat inexperienced analyst at Fidelity. Kaiser Industries had already dropped from $25 to $13. On my recommendation Fidelity bought five million shares—one of the biggest blocks ever traded in the history of the American Stock Exchange—when the stock hit $11. I confidently asserted that there was no way the stock could go below $10.
When it reached $8, I called my mother and told her to go out and buy it, since it was absolutely inconceivable that Kaiser would drop below $7.50. Fortunately my mother didn’t listen to me. I watched with horror as Kaiser faded from $7 to $6 to $4 in 1973—where it finally proved that it couldn’t go much lower.”
Now, it may be the case that you are simply wrong in your timing, and that your stock really is underpriced. In theory, value investors should not be overly concerned if their holdings underperform in the short term. In practice, though, no one wants to sit on a net loss second-guessing themselves.
“Eventually, they always come back”
“So will the Visigoths and the Picts and Ghengis Khan ride again. People said RCA would come back, and after 65 it never did. This was a world-famous successful company...If I could only remember the names, I could give you a much longer list of smaller and less-known public companies whose blips have disappeared forever. Perhaps you’ve invested in a few of these yourself - I wouldn’t want to think I was the only one. When you consider the thousands of bankrupt companies that get bought out at prices that are far below the all-time highs, you can begin to see the weakness in the 'they always come back argument.'”
This passage reminds me of a quip issued by a former trader boss of mine. At the time, everyone in the office was trading the spread between the German Dax index and the European Euro Stoxx. He would say, “Remember, if it goes down, buy the spread. It always comes back. Until it doesn’t.”
Read more here:
- Bruce Greenwald: Why Short-Term Investing Is Difficult to Do
- Lawrence Cunningham: How Warren Buffett Triumphed Over Modern Portfolio Theory
- Will a US-China Trade Deal at the G20 Summit Boost Growth?
Not a Premium Member of GuruFocus? Sign up for a free 7-day trial here.
