A legend’s words to the layman investor
In the world of investing, Peter Lynch is legendary having delivered an annualized return of 29% over a 13-year period, one of the greatest investing track records of all time.
When Lynch became Magellan’s manager in 1977, the fund had $18 million in assets. It went on to become the largest mutual fund in the U.S. with ~$14 billion in assets. The ability to manage such a humongous amount and deliver admirably earned him a position in the investing hall of fame.
Some of his pearls of wisdom form the basis of my article this week.
All your stocks will not do well.
You only find a few good stocks in your lifetime.
In your portfolio, some will do mediocre, some will do okay, and if one of two of them goes up big time, you will produce an overall good result. Some stocks can go up 20%-30% and eager investors book profits and get rid of it, holding on to the dogs. In this business if you’re good, you’re right 6/10. You’re never going to be right 9/10. You will have to take a little bit of risk.
But remember, you have to let the big ones make up for your mistakes.
Each stock you own is a piece of ownership in a real business. If you looked at 10 companies, you will find one that is interesting. Look at 20, you will find two. Look at a 100, you will find 10. The person that turns over the most rocks wins the game.
Don’t get easily afraid.
The unwary investors pass in and out of three emotional states: Concern, Complacency, Capitulation.
- Concern after the market has dropped or the economy seemingly falters. This is a hindrance to buying good companies at bargain prices.
- When the investor buys at higher prices, complacency sets in because the stock price keeps rising higher. Ironically, this is the time when one should be cautious, and fundamentals checked.
- Finally, when the stock crashes to prices below the buying price, the investor capitulates and sells at loss.
Such investors fancy themselves to be long-term investors but only until the next big drop, at which point they quickly become short-term investors and sell out for huge losses.
Accept periodic losses
People who succeed in the stock market accept periodic losses. Calamitous drops do not scare them out of the game. The trick is not to trust your gut feelings, but to discipline yourself to ignore them.
Researching fundamentals help keep you grounded.
Do your homework
Invest in a company after you have done the homework on the company’s earnings prospects, financial condition, competitive position, plans for expansion and so forth. Stand by your stock as long as the fundamental story behind it has not changed.
The year 1982 was a very scary period for America. Recession. Inflation at 14%. The prime rate was 20%. The economy was apparently in a free fall. One of Fidelity shareholders wrote to Lynch and questioned: “Do you realize that over half the companies in your portfolio are losing money right now?” Lynch answered: “These companies are going to do well once the economy comes back. We’ve got out of every other recession. I don’t see why we won’t come out of this one.” He was proved right. The market eventually went north.
Avoid the hottest stock in the hottest industry.”
Hot stocks in hot industries are defined as those that get a lot of early publicity. They may see huge growth at the start but burn out quickly as investors realize that they do not have the earnings, profits, or growth potential to back the buzz.
Also, competitors looking to cash in on a hot product’s novelty will eventually enter the market with a copycat version and deflate the original company’s stock value. When the price falls, it can often fall quite a bit. If you don’t know when to sell, you could quickly lose all your profits.
Big companies have small moves; small companies have big moves.
The market has already deemed what a stock is worth via its current market price. If you expect the company to rise in value, one of three things must happen:
- The company expands. For retailers, this is preferably done through organic sales and store growth.
- The company’s earnings, sales, and profit margins improve.
- The market undervalues the stock, or its quality is not fully seen.
Great small companies often fit two of these factors. They are also not closely watched by analysts, so the chance of undervaluation is high. Institutional investors often avoid small-cap stocks for years because they can’t buy enough shares to impact their bottom line. When they finally start to scoop up the small number of shares, a small-cap retailer’s price can rise quickly.
Pointers for research
As oft repeated by us, don’t look at macro-economics to predict the future. Focus on your companies. If you own auto stocks, you should be very interested in
used car prices. If you own metal stocks, you ought to be interested in what’s happened to inventories of the metal. If it’s hotel stocks, your research should lead you to find out how many people are building hotels. Deal with facts, not forecasting the future. That’s crystal ball stuff. That doesn’t work. Futile.
If you think you can play the market, you will get played.
People who are no good at picking stocks are the very ones who say they are “playing the market,” as if it is a game. When you “play the market” you are looking for instant gratification, without having to do any work. You are seeking the excitement that comes from owning one stock one week and another the next. “Playing the market” is an incredibly damaging pastime.
Research your company like you would, buying a refrigerator
The public looks at stocks differently than they look at everything else. When they buy a refrigerator, they do research. They spend weeks planning a trip and hours studying their frequent flier plans. When they buy a microwave oven, they do research. They’ll get consumer reports and ask other individuals on what they favorite kind of oven is or what kind of car would they buy and why. But they will invest Rs10,00,000 in some stock that they heard about on a bus on the way to work. And they do it before sunset with no clue what the company does. And then wonder why they lose money.
In the end, they are more convinced than ever that investing in stocks is a game, but that’s because they have made it one.
