by Peter Lynch
Peter Lynch is America’s number-one money manager. His mantra: Average investors can become experts in their own field and can pick winning stocks as effectively as Wall Street professionals by doing just a little research.
Now, in a new introduction written specifically for this edition of One Up on Wall Street, Lynch gives his take on the incredible rise of Internet stocks, as well as a list of twenty winning companies of high-tech ’90s. That many of these winners are low-tech supports his thesis that amateur investors can continue to reap exceptional rewards from mundane, easy-to-understand companies they encounter in their daily lives.
Investment opportunities abound for the layperson, Lynch says. By simply observing business developments and taking notice of your immediate world—from the mall to the workplace—you can discover potentially successful companies before professional analysts do. This jump on the experts is what produces “tenbaggers,” the stocks that appreciate tenfold or more and turn an average stock portfolio into a star performer.
The former star manager of Fidelity’s multibillion-dollar Magellan Fund, Lynch reveals how he achieved his spectacular record. Writing with John Rothchild, Lynch offers easy-to-follow directions for sorting out the long shots from the no shots by reviewing a company’s financial statements and by identifying which numbers really count. He explains how to stalk tenbaggers and lays out the guidelines for investing in cyclical, turnaround, and fast-growing companies.
Lynch promises that if you ignore the ups and downs of the market and the endless speculation about interest rates, in the long term (anywhere from five to fifteen years) your portfolio will reward you. This advice has proved to be timeless and has made One Up on Wall Street a number-one bestseller. And now this classic is as valuable in the new millennium as ever.
PETER LYNCH is vice chairman of Fidelity Management & Research Company—the investment advisor arm of Fidelity Investments—and a member of the Board of Trustees of the Fidelity funds. Mr. Lynch was portfolio manager of Fidelity Magellan Fund, which was the best performing fund in the world under his leadership from May 1977 to May 1990. He is the co-author of the bestselling Beating the Street and Learn to Earn, a beginner’s guide to the basics of investing and business. He lives in the Boston area.
JOHN ROTHCHILD has written for Time, Fortune, Worth, and The New York Times Book Review. The author of A Fool and His Money and Going for Broke, he is also the co-author, with Peter Lynch, of Beating the Street and Learn to Earn. He lives in Miami Beach, Florida.
Cover design by Tom Lau
Cover photograph by Sigrid Estrada
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Copyright © 1989 by Peter Lynch
Introduction copyright © 2000 by Peter Lynch
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First Fireside Edition 2000
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ISBN 0-7432-0040-3
ISBN: 978-1-4391-2615-8 (eBook)
To Carolyn, my wife and best friend for over twenty years, whose support and sacrifices have been critically important to me.
To my children, Mary, Annie, and Beth, whose love for each other and their parents has meant so very much.
To my colleagues at Fidelity Investments, whose extra efforts have made Magellan’s performance possible but who have received none of the favorable publicity.
To one million shareholders in Magellan, who have entrusted their savings to me and who have sent thousands of letters and made thousands of calls over the years, comforting me during declines in the market and reminding me that the future will be fine.
To Holy God for all the incredible blessings I have been given in my life.
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Contents
Introduction to the Millennium Edition
PROLOGUE: A Note from Ireland
INTRODUCTION: The Advantages of Dumb Money
PART I: Preparing to Invest
1: The Making of a Stockpicker
2: The Wall Street Oxymorons
3: Is This Gambling, or What?
4: Passing the Mirror Test
5: Is This a Good Market? Please Don’t Ask
PART II: Picking Winners
6: Stalking the Tenbagger
7: I’ve Got It, I’ve Got It—What Is It?
8: The Perfect Stock, What a Deal!
9: Stocks I’d Avoid
10: Earnings, Earnings, Earnings
11: The Two-Minute Drill
12: Getting the Facts
13: Some Famous Numbers
14: Rechecking the Story
15: The Final Checklist
PART III: The Long-term View
16: Designing a Portfolio
17: The Best Time to Buy and Sell
18: The Twelve Silliest (and Most Dangerous) Things People Say About Stock Prices
19: Options, Futures, and Shorts
20: 50,000 Frenchmen Can Be Wrong
EPILOGUE: Caught with My Pants Up
ACKNOWLEDGMENTS
INDEX
Introduction to the Millennium Edition
This book was written to offer encouragement and basic information to the individual investor. Who knew it would go through thirty printings and sell more than one million copies? As this latest edition appears eleven years beyond the first, I’m convinced that the same principles that helped me perform well at the Fidelity Magellan Fund still apply to investing in stocks today.
It’s been a remarkable stretch since One Up on Wall Street hit the bookstores in 1989. I left Magellan in May, 1990, and pundits said it was a brilliant move. They congratulated me for getting out at the right time—just before the collapse of the great bull market. For the moment, the pessimists looked smart. The country’s major banks flirted with insolvency, and a few went belly up. By early fall, war was brewing in Iraq. Stocks suffered one of their worst declines in recent memory. But then the war was won, the banking system survived, and stocks rebounded.
Some rebound! The Dow is up more than fourfold since October, 1990, from the 2,400 level to 11,000 and beyond—the best decade for stocks in the twentieth century. Nearly 50 percent of U.S. households own stocks or mutual funds, up from 32 percent in 1989. The market at large has created $25 trillion in new wealth, which is on display in every city and town. If this keeps up, somebody will write a book called The Billionaire Next Door.
More than $4 trillion of that new wealth is invested in mutual funds, up from $275 billion in 1989. The fund bonanza is okay by me, since I managed a fund. But it also must mean a lot of amateur stockpickers did poorly with their picks. If they’d done better on their own in this mother of all bull markets, they wouldn’t have migrated to funds to the extent they have. Perhaps the information contained in this book will set some e
rrant stockpickers on a more profitable path.
Since stepping down at Magellan, I’ve become an individual investor myself. On the charitable front, I raise scholarship money to send inner-city kids of all faiths to Boston Catholic schools. Otherwise, I work part-time at Fidelity as a fund trustee and as an adviser/trainer for young research analysts. Lately my leisure time is up at least thirtyfold, as I spend more time with my family at home and abroad.
Enough about me. Let’s get back to my favorite subject: stocks. From the start of this bull market in August 1982, we’ve seen the greatest advance in stock prices in U.S. history, with the Dow up fifteenfold. In Lynch lingo that’s a “fifteenbagger.” I’m accustomed to finding fifteen-baggers in a variety of successful companies, but a fifteenbagger in the market at large is a stunning reward. Consider this: From the top in 1929 through 1982, the Dow produced only a fourbagger: up from 248 to 1,046 in a half century! Lately stock prices have risen faster as they’ve moved higher. It took the Dow 8⅓ years to double from 2,500 to 5,000, and only 3½ years to double from 5,000 to 10,000. From 1995–99 we saw an unprecedented five straight years where stocks returned 20 percent plus. Never before has the market recorded more than two back-to-back 20 percent gains.
Wall Street’s greatest bull market has rewarded the believers and confounded the skeptics to a degree neither side could have imagined in the doldrums of the early 1970s, when I first took the helm at Magellan. At that low point, demoralized investors had to remind themselves that bear markets don’t last forever, and those with patience held on to their stocks and mutual funds for the fifteen years it took the Dow and other averages to regain the prices reached in the mid-1960s. Today it’s worth reminding ourselves that bull markets don’t last forever and that patience is required in both directions.
On of this book I say the breakup of ATT in 1984 may have been the most significant stock market development of that era. Today it’s the Internet, and so far the Internet has passed me by. All along I’ve been technophobic. My experience shows you don’t have to be trendy to succeed as an investor. In fact, most great investors I know (Warren Buffett, for starters) are technophobes. They don’t own what they don’t understand, and neither do I. I understand Dunkin’ Donuts and Chrysler, which is why both inhabited my portfolio. I understand banks, savings-and-loans, and their close relative, Fannie Mae. I don’t visit the Web. I’ve never surfed on it or chatted across it. Without expert help (from my wife or my children, for instance) I couldn’t find the Web.
Over the Thanksgiving holidays in 1997, I shared eggnog with a Web-tolerant friend in New York. I mentioned that my wife, Carolyn, liked the mystery novelist Dorothy Sayers. The friend sat down at a nearby computer and in a couple of clicks pulled up the entire list of Sayers titles, plus customer reviews and the one-to five-star ratings (on the literary Web sites, authors are rated like fund managers). I bought four Sayers novels for Carolyn, picked the gift wrapping, typed in our home address, and crossed one Christmas gift off my list. This was my introduction to Amazon.com.
Later on you’ll read how I discovered some of my best stocks through eating or shopping, sometimes long before other professional stock hounds came across them. Since Amazon existed in cyberspace, and not in suburban mall space, I ignored it. Amazon wasn’t beyond my comprehension—the business was as understandable as a dry cleaner’s. Also, in 1997 it was reasonably priced relative to its prospects, and it was well-financed. But I wasn’t flexible enough to see opportunity in this new guise. Had I bothered to do the research, I would have seen the huge market for this sort of shopping and Amazon’s ability to capture it. Alas, I didn’t. Meanwhile, Amazon was up tenfold (a “tenbagger” in Lynch parlance) in 1998 alone.
Amazon is one of at least five hundred “dot.com” stocks that have performed miraculous levitations. In high-tech and dot.com circles, it’s not unusual for a newly launched public offering to rise tenfold in less time than it takes Stephen King to pen another thriller. These investments don’t require much patience. Before the Internet came along, companies had to grow their way into the billion-dollar ranks. Now they can reach billion-dollar valuations before they’ve turned a profit or, in some cases, before they’ve collected any revenues. Mr. Market (a fictional proxy for stocks in general) doesn’t wait for a newborn Website to prove itself in real life the way, say, Wal-Mart or Home Depot proved themselves in the last generation.
With today’s hot Internet stocks, fundamentals are old hat. (The term old hat is old hat in itself, proving that I’m old hat for bringing it up.) The mere appearance of a dot and a com, and the exciting concept behind it, is enough to convince today’s optimists to pay for a decade’s worth of growth and prosperity in advance. Subsequent buyers pay escalating prices based on the futuristic “fundamentals,” which improve with each uptick.
Judging by the Maserati sales in Silicon Valley, dot.coms are highly rewarding to entrepreneurs who take them public and early buyers who make timely exits. But I’d like to pass along a word of caution to people who buy shares after they’ve levitated. Does it make sense to invest in a dot.com at prices that already reflect years of rapid earnings growth that may or may not occur? By the way I pose this, you’ve already figured out my answer is “no.” With many of these new issues, the stock price doubles, triples, or even quadruples on the first day of trading. Unless your broker can stake your claim to a meaningful allotment of shares at the initial offering price—an unlikely prospect since Internet offerings are more coveted, even, than Super Bowl tickets—you’ll miss a big percent of the gain. Perhaps you’ll miss the entire gain, since some dot.coms hit high prices on the first few trading sessions that they never reach again.
If you feel left out of the dot.com jubilee, remind yourself that very few dot.com investors benefit from the full ride. It’s misleading to measure the progress of these stocks from the offering price that most buyers can’t get. Those who are allotted shares are lucky to receive more than a handful.
In spite of the instant gratification that surrounds me, I’ve continued to invest the old-fashioned way. I own stocks where results depend on ancient fundamentals: a successful company enters new markets, its earnings rise, and the share price follows along. Or a flawed company turns itself around. The typical big winner in the Lynch portfolio (I continue to pick my share of losers, too!) generally takes three to ten years or more to play out.
Owing to the lack of earnings in dot.com land, most dot.coms can’t be rated using the standard price/earnings yardstick. In other words, there’s no “e” in the all-important “p/e” ratio. Without a “p/e” ratio to track, investors focus on the one bit of data that shows up everywhere: the stock price! To my mind, the stock price is the least useful information you can track, and it’s the most widely tracked. When One Up was written in 1989, a lone ticker tape ran across the bottom of the Financial News Network. Today you can find a ticker tape on a variety of channels, while others display little boxes that showcase the Dow, the S&P 500, and so forth. Channel surfers can’t avoid knowing where the market closed. On the popular Internet portals, you can click on your customized portfolio and get the latest gyrations for every holding. Or you can get stock prices on 800 lines, pagers, and voice mail.
To me, this barrage of price tags sends the wrong message. If my favorite Internet company sells for $30 a share, and yours sells for $10, then people who focus on price would say that mine is the superior company. This is a dangerous delusion. What Mr. Market pays for a stock today or next week doesn’t tell you which company has the best chance to succeed two to three years down the information superhighway. If you can follow only one bit of data, follow the earnings—assuming the company in question has earnings. As you’ll see in this text, I subscribe to the crusty notion that sooner or later earnings make or break an investment in equities. What the stock price does today, tomorrow, or next week is only a distraction.
The Internet is far from the first innovation that changed the world. The rai
lroad, telephone, the car, the airplane, and the TV can all lay claim to revolutionary effects on the average life, or at least on the prosperous top quarter of the global population. These new industries spawned new companies, only a few of which survived to dominate the field. The same thing likely will happen with the Internet. A big name or two will capture the territory, the way McDonald’s did with burgers or Schlumberger did with oil services. Shareholders in those triumphant companies will prosper, while shareholders in the laggards, the has-beens, and the should-have-beens will lose money. Perhaps you’ll be clever enough to pick the big winners that join the exclusive club of companies that earn $1 billion a year.
Though the typical dot.com has no earnings as yet, you can do a thumbnail analysis that gives a general idea of what the company will need to earn in the future to justify the stock price today. Let’s take a hypothetical case: DotCom.com. First, you find the “market capitalization” (“market cap” for short) by multiplying the number of shares outstanding (let’s say 100 million) by the current stock price (let’s say $100 a share). One hundred million times $100 equals $10 billion, so that’s the market cap for DotCom.com.
Whenever you invest in any company, you’re looking for its market cap to rise. This can’t happen unless buyers are paying higher prices for the shares, making your investment more valuable. With that in mind, before DotCom.com can turn into a tenbagger, its market cap must increase tenfold, from $10 billion to $100 billion. Once you’ve established this target market cap, you have to ask yourself: What will DotCom.com need to earn to support a $100 billion valuation? To get a ballpark answer, you can apply a generic price/earnings ratio for a fast-growing operation—in today’s heady market, let’s say 40 times earnings.
Permit me a digression here. On I mention how wonderful companies become risky investments when people overpay for them, using McDonald’s as exhibit A. In 1972 the stock was bid up to a precarious 50 times earnings. With no way to “live up to these expectations,” the price fell from $75 to $25, a great buying opportunity at a “more realistic” 13 times earnings.