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Robert Abbott
Robert Abbott
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Beating the Street: The Art, Science and Legwork of Investing

Peter Lynch’s thoughts on the broad outlines of investing in stocks

October 22, 2019 | About:

If anyone has had an abundance of experience picking stocks, it would certainly be Peter Lynch, the author “Beating the Street” (1993) and "One Up on Wall Street" (1989). While managing Fidelity’s Magellan Fund between 1977 and 1990, he bought and sold literally thousands of companies. And he earned exceptional returns while doing so.

In chapter seven of “Beating the Street,” he summarized that experience as “Art, Science, and Legwork.” He wrote:

“Stockpicking is both an art and a science, but too much of either is a dangerous thing. A person infatuated with measurement, who has his head stuck in the sand of the balance sheets, is not likely to succeed. If you could tell the future from a balance sheet, then mathematicians and accountants would be the richest people in the world by now. A misguided faith in measurement has proved harmful as far back as Thales, the early Greek philosopher who was so intent on counting stars that he kept falling into potholes in the road.”

Lynch was equally dismissive of too much art in stockpicking, and defined art as the use of intuition and other right brain-inspired ideas. Those who push the art of investing too far fail to do research and instead “play the market.”

He also had little use for professional investors who think they can learn about stocks by watching what other professional investors are doing “when they ought to be spending more time at the mall. A pile of software isn’t worth a damn if you haven’t done your basic homework.”

What he did like was the hard work of research, which he also did earlier in his career:

“I’ve always believed that searching for companies is like looking for grubs under rocks: if you turn over 10 rocks you’ll likely find one grub; if you turn over 20 rocks you’ll find two. During the four-year stretch mentioned above, I had to turn over thousands of rocks a year to find enough new grubs to add to Magellan’s outsized collection.”

After he retired from Magellan, he no longer had time to turn over so many rocks. As a personal investor and volunteer advisor to several charities, he cut back drastically on research and had this advice for non-professional investors:

“The part-time stockpicker doesn’t need to find 50 or 100 winning stocks. It only takes a couple of big winners in a decade to make the effort worthwhile. The smallest investor can follow the Rule of Five and limit the portfolio to five issues. If just one of those is a 10-bagger and the other four combined go nowhere, you’ve still tripled your money.”

Turning to the subject of overpriced markets, he admitted they depressed him; he would much rather see “a beaten-down market in a recession.” According to Lynch, recessions always end, sooner or later, but while they are in place, there are many bargains. On the other hand, when the market is booming and overpriced, there are few stocks worth buying.

He next turned to large, rapidly-growing companies of the early 1990s, including Philip Morris (NYSE:PM), Abbott (NYSE:ABT), Walmart (NYSE:WMT) and Bristol-Myers Squibb (NYSE:BMY). They were bad bets because they had “strayed far above their earnings lines.” Here is an example using the GuruFocus chart for Bristol-Myers Squibb; it shows the relationship between share prices and earnings:

GuruFocus Bristol-Meyers Squibb Peter Lynch chart

These charts are automatically created for GuruFocus subscribers; scroll down the summary page for any covered stock.

Lynch famously discovered that stocks with prices higher than their earnings lines had a habit of moving sideways or falling in price. His advice in a nutshell: “Buy shares when the stock price is at or below the earnings line, and not when the price line diverges into the danger zone, way above the earnings line.”

While larger, rapidly-growing stocks were overpriced, at the time this book was written, many smaller stocks were not. That was especially true in November and December, when tax-selling before year-end was in progress. He added:

“You could make a nice living buying stocks from the low list in November and December during the tax-selling period and then holding them through January, when the prices always seem to rebound. This January effect, as it’s called, is especially powerful with smaller companies, which over the last 60 years have risen 6.86 percent in price in that one month, while stocks in general have risen only 1.6 percent.”

According to Lynch, you shouldn’t go looking for new stocks simply for the sake of doing so. He recommended getting to know a manageable number of companies and then staying within that universe. You will have learned about the industry and the places of individual companies within it. And, “Inevitably, some gloomy scenario will cause a general retreat in the stock market, your old favorites will once again become bargains, and you can add to your investment.”

Buying, selling and then forgetting about companies is the opposite approach and not a good one. He wrote:

“Along the way, I’ve also learned to think of investments not as disconnected events, but as continuing sagas, which need to be rechecked from time to time for new twists and turns in the plots. Unless a company goes bankrupt, the story is never over. A stock you might have owned 10 years ago, or 2 years ago, may be worth buying again.”

He learned to keep a record of every stock he bought, along with the reasons why he bought and sold it.

Conclusion

For Lynch, there are three major inputs into investments: art, science and legwork. In chapter seven of “Beating the Street,” he explained that good investments would come from a mix of all three inputs and by avoiding too much concentration on any one of them.

He gave examples of the science of investing by discussing approaches such as only buying when the stock price is below the earnings line or buying in December and selling in January.

There are fewer lessons about art and legwork, but several ideas from earlier chapters and his earlier book come to mind. Legwork in the sense of visiting companies and visiting shopping malls, and art in the sense of having an idea of what a stock will do after you buy it.

Disclosure: I do not own shares in any company listed, and do not expect to buy any in the next 72 hours.

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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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