Brilliant yet practical investment advice from legendary money manager Peter Lynch. Follow-up to One Up On Wall Street, it's as funny as it is perceptive.
- Peter’s Principle #1: When the operas outnumber the football games three to zero, you know there is something wrong with your life.
- …putting money into stocks is far more profitable than putting it into bonds, certificates of deposit, or money-market accounts.
- By sticking with stocks, all the time, the odds are six to one in our favor that we’ll do better than the people who stick with bonds.
- Over the entire 64 years covered in the table, a $100,000 investment in long-term government bonds would now be worth $1.6 million, whereas the same amount invested in the S&P 500 would be worth $25.5 million.
- Peter’s Principle #2: Gentlemen who prefer bonds don’t know what they’re missing.
- I’ve said before that an amateur who devotes a small amount of study to companies in an industry he or she knows something about can outperform 95 percent of the paid experts who manage the mutual funds, plus have fun in doing it.
- Whatever method you use to pick stocks or stock mutual funds, your ultimate success or failure will depend on your ability to ignore the worries of the world long enough to allow your investments to succeed.
- It isn’t the head but the stomach that determines the fate of the stockpicker.
One: The Miracle of St. Agnes
- The stock market is the one place where the high achiever is routinely show up. It’s easy to get an F here. If you buy futures and options and attempt to time the market, it’s easy to get all F’s…
- Peter’s Principle #3: Never invest in any idea you can’t illustrate with a crayon.
- This rule ought to be adopted by many adult money managers, amateur and professional, who have a habit of ignoring the understandable profitable enterprise in favor of the inexplicable venture that loses money.
- You can lose money in a very short time but it takes a long time to make money.
- You should not buy a stock because it’s cheap but because you know a lot about it.
- In 40 years of experience, the NAIC has learned many of the same lessons I learned at Magellan, beginning with the fact that if you pick stocks in five different growth companies, you’ll find that three will perform as expected, one will run into unforeseen trouble and will disappoint you, and the fifth will do better than you could have imagined and will surprise you with a phenomenal return.
The NAIC manual…contains several important maxims…
- Hold no more stocks than you can remain informed on.
- Invest regularly.
- You want to see, first, that sales and earnings per share are moving forward at an acceptable rate and, second, that you can buy the stock at a reasonable price.
- It is well to consider the financial strength and debt structure to see if a few bad years would hinder the company’s long-term progress.
- Buy or do not buy the stock on the basis of whether or not the growth meets your objectives and whether the price is reasonable.
- Understanding the reasons for past sales growth will help you form a good judgment as to the likelihood of past growth rates continuing.
Two: The Weekend Worrier
- The key to making money in stocks is not to get scared out of them. This point cannot be overemphasized.
- While catching up on the news is merely depressing to the citizen who has not stocks, it is a dangerous habit for the investor.
- Peter’s Principle #4: You can’t see the future through a rearview mirror.
- If Bernard Baruch was right about selling all stocks when the shoeshine boys are buying, then surely the right time to be buying is when the barbers discover puts.
The Even Bigger Picture
- The best way not to be scared out of stocks is to buy them on a regular schedule, month in and month out, which is what many people are doing in the 401(k) retirement plans and in their investment clubs…
- Keeping the faith and stock picking are normally not discussed in the same paragraph, but success in the latter depends on the former.
- A decline in stocks is not a surprising event, it’s a recurring event—as normal as frigid air in Minnesota.
- A successful stock picker has the same relationship with a drop in the market as a Minnesotan has with freezing weather. You know it’s coming, and you’re ready to ride it out, and when your favorite stocks go down with the rest, you jump at the chance to buy more.
Three: A Tour of the Fund House
- Mutual funds were supposed to take the confusion out of investing—no more worrying about which stock to pick. Not anymore.
- We’re lately reached an important milestone in fund making history: the number of funds now exceeds the number of individual stocks traded on the New York and American stock exchanges combined.
- Peter’s Principle #5: There’s no point paying Yo-Yo Ma to play a radio.
- Warren Buffett’s admonition that people who can’t tolerate seeing their stocks lose 50 percent of their value shouldn’t own stocks also applies to stock funds.
- Peter’s Principle #6: As long as you’re picking a fund, you might as well pick a good one.
- There’s something to be said for the dartboard method of investing: buy the whole dartboard.
The All-Star Team
- Since 1926, emerging growth stocks have outperformed the S&P 500 by a substantial margin…
- But it’s better to stick with a steady and consistent performer than to move in and out of funds, trying to catch the waves.
If It’s Tuesday, It Must Be the Belgium Fund
- In the U.S., what makes stockpicking difficult is that 1,000 people smarter than you are studying the same stocks you are.
- Speculation plays a much larger role in the Japanese economy than in the U.S. economy.
- All things considered, I’d rather be invested in a solid emerging-growth stock mutual fund in the good old U.S.A.
- Put as much of your money into stock funds as you can.
- If you must own government bonds, buy them outright from the Treasury and avoid the bond funds, in which you’re paying management fees for nothing.
- Constantly switching your money from one fund to another is an expensive habit that is harmful to your net worth.
Four: Managing Magellan / The Early Years
- Peter’s Principle #7: The extravagance of any corporate office is directly proportional to management’s reluctance to reward shareholders.
- There were always undervalue companies to be found somewhere.
- I was attracted to fast-food restaurants because they were so easy to understand. A restaurant chain that succeeded in one region had an excellent chance of duplicating its success in another.
- By abandoning these great companies for lesser issues, I became a victim of the all-too-common practice of “pulling out the flowers and watering the weeds”…
Taking Union Carbide to Lunch
- I always ended those discussions by asking: which of your competitors do you respect the most?
- As is often the case, just when people began to feel it was safe to return to stocks, stocks suffered a correction.
- When stocks in good companies are selling at 3-6 times earnings, the stock picker can hardly lose.
Five: Magellan / The Middle Years
Far From a One-Man Show
- Ned Johnson [founder of Fidelity Investments] loved the idea of people working extra hard.
- My methods were not much different from those of an investigative reporter—reading the public documents for clues, talking with intermediaries such as analysts and investor relations people for more clues, and then going directly to the primary sources: the companies themselves.
My Not-So-Silent Partners
- They proved that the best way to get the most out of a staff is to give people full responsibility. Usually they will live up to it.
- If you’re prepared to invest in a company, then you ought to be able to explain why in simple language that a fifth grader could understand, and quickly enough so that a fifth grader won’t get bored.
It Pays to Be Patient
- I was progressively more impressed with the long-range potential of restaurant chains and retailers. By expanding across the country, these companies could keep up a 20 percent growth gate for 10 to 15 years.
- The math was, and continues to be, very favorable. If earnings increase 20 percent per annum, they double in 3 1/2 years and quadruple in 7.
- The rule of 72 is useful in determining how fast money will grow. Take the annual return from any investment, expressed as a percentage, and divide it into 72. The result is the number of years it will take to double your money.
- With a 25 percent return, your money doubles in less than 3 years: with a 15 percent return, it doubles in less than 5.
- Peter’s Principle #8: When yields on long-term government bonds exceed the dividend yield of the S&P 500 by 6 percent of more, sell your stocks and buy bonds.
- If there’s anything as certain as death and the collapse of the Red Sox, it’s that Americans have to buy cars.
- No matter how well you think you understand a business, something can always happen that will surprise you.
- I subscribed to Edison’s theory that “investing is ninety-nine percent perspiration”…
- Bargains are the holy grail of the true stockpicker. The fact that 10-30 percent of our net worth is lost in a market sell-off is of little consequence. We see the latest correction not as a disaster but ask an opportunity to acquire more shares at low prices. This is how great fortunes are made over time.
Six: Magellan / The Later Years
- Peter’s Principle #9: Not all common stocks are equally common.
- In stocks as in romance, ease of divorce is not a sound basis for commitment. If you’ve chosen wisely to begin with, you won’t want a divorce.
- Peter’s Principle #10: Never look back when you’re driving on the authobahn.
- Peter’s Principle #11: The best stock may be the one you already own.
A Tactical Shift
- Peter’s Principle #12: A sure cure for taking a stock for granted is a big drop in the price.
- Perhaps there’s some poetic justice in the fact that the stocks that take you the farthest in the long run give you the most bumps and bruises along the way.
Good Money After Bad
- This is an important aspect of portfolio management—containing your losses.
- There’s no shame in losing money on a stock. Everybody does it. What is shameful is to hold on to a stock, or, worse, to buy more of it, when the fundamentals are deteriorating.
- Peter’s Principle #13: Never bet on a comeback while they’re playing “Taps.”
- Since bonds come before stocks in the lineup of claimants on the company’s assets, you can be sure that when bonds sell for next to nothing, the stock will be worth even less.
Seven: Art, Science, and Legwork
- Stockpicking is both an art and a science, but too much of either is a dangerous thing.
- 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.
Eight: Shopping For Stocks / The Retail Sector
- Peter’s Principle #14: If you like the store, chances are you’ll love the stock.
- (Same store sales is one of the two to three key factors in analyzing a retail operation.)
- As a rule of thumb, a stock should sell at or below its growth rate—that is, the rate at which it increases its earnings every year.
- Even the fastest-growing companies can rarely achieve more than a 25 percent growth rate, and a 40 percent growth rate is a rarity. Such frenetic progress cannot long be sustained, and companies that grow too fast tend to self-destruct.
- A company with a high p/e [price/earnings ratio] that’s growing at a fast rate will eventually outperform one with a lower p/e that’s growing at a slower rate.
- The best way to handle a situation in which you love the company but not the current price is to make a small commitment and then increase it in the next sell-off.
- If anybody ever tells you that a stock that’s already gone up 10-fold or 50-fold cannot possibly go higher, show that person the Wal-Mart chart.
- The important issue to analyze was not whether Wal-Mart stock would punish the greed of its shareholders, but whether the company had saturated its market.
- In a retail company or a restaurant chain, the growth that propels earnings and the stock price comes mainly from expansion. As long as the same-store sales are on the increase (these numbers are shown in annual and quarterly reports), the company is not crippled by excessive debt, and it is following its expansion lans as described to shareholders in its reports, it usually pays to stick with the stock.
Nine: Prospecting in Bad News / How the “Collapse” in Real Estate Led Me to Pier 1, Sunbelt Nursery, and General Host
- A technique that works repeatedly is to wait until the prevailing opinion about a certain industry is that things have gone from bad to worse, and then buy shares in the strongest companies in the group.
- One way to estimate the actual worth of a company is to use the home buyer’s technique of comparing it to similar properties that recently have been sold in the neighborhood.
- When a company buys back shares that once paid a dividend and borrows the money to do it, it enjoys a double advantage. The interest on the loan is tax-deductible, and the company is reducing its outlay for dividend checks, which it had to pay in after-tax dollars.
- Peter’s Principle #15: When insiders are buying, it’s a good sign—unless they happen to be New England bankers.
- The difference between the two sides, all the assets minus all the liabilities, is what belongs to the shareholders. This is called the shareholder’s equity.
- The goodwill is the amount that has been paid for an acquisition above and beyond the book value of the actual assets.
- What you want to see on the balance sheet is at least twice as much equity as debt, and the more equity and the less debt the better.
- In a highly leveraged company, bank debt is dangerous, because if the company runs into problems the bank will ask for its money back.
- You don’t want the company to have too much inventory. When inventories are allowed to build, this overstates a company’s earnings.
- A hefty accounts payable is OK.
Eleven: Blossoms in the Dessert / Great Companies in Lousy Industries
Sun Television & Appliances
- I’m always on the lookout for great companies in lousy industries.
- A great industry that’s growing fast, such as computers or medical technology, attracts too much attention and too many competitors. As Yogi Berra once said about a famous Miami Beach restaurant, “It’s so popular, nobody goes there anymore.”
- As a place to invest, I’ll take a lousy industry over a great industry anytime. In a lousy industry, one that’s growing slowly if at all, the weak drop out and the survivors get a bigger share of the market. A company that can capture an ever-increasing share of a stagnant market is a lot better off than one that has to struggle to protect a dwindling share of an exciting market.
- Peter’s Principle #16: In business, competition is never as healthy as total domination.
- The greatest companies in lousy industries share certain characteristics.
- They are low-cost operators, and penny-pinchers in the executive suite. They avoid going into debt. They reject the corporate caste system that creates white-collar Brahmins and blue-collar untouchables. Their workers are well paid and have a stake in the companies’ future. They find niches, parts of the market that bigger companies have overlooked. They grow fast—faster than many companies in the fashionable fast-growth industries.
- Peter’s Principle #17: All else being equal, invest in the company with the fewest color photographs in the annual report.
Twelve: It’s A Wonderful Buy
- Peter’s Principle #18: When even the analysts are bored, it’s time to start buying.
- Before I invest in any S&L, I like to see that its E/A ratio is at least 7.5.
Thirteen: A Closer Look at the S&Ls
- …it’s a bad thing when a company increases the number of shares.
Fifteen: The Cyclicals / What Goes Around Comes Around
- Peter’s Principle #19: Unless you’re a short seller or a poet looking for a wealthy spouse, it never pays to be pessimistic.
- The most important question to ask about a cyclical is whether the company’s balance sheet is strong enough to survive the next downturn.
- When used-car dealers lower their prices, it mans they’re having trouble selling cars, and a lousy market for them is even lousier for the new-car dealers.
- But when used-car prices are on the rise, it’s a sign of good times ahead for the automakers.
- After four or five years when sales are under the trend, it takes another four or five years of sales above the trend before the car market can catch up to itself.
Sixteen: Nukes in Distress / CMS Energy
- Peter’s Principle #20: Corporations, like people, change their names for one of two reasons: either they’ve gotten married, or they’ve been involved in some fiasco that they hope the public will forget.
Seventeen: Uncle Sam’s Garage Sale / Allied Capital II
- Peter’s Principle #21: Whatever the queen is selling, buy it.
Eighteen: My Fannie Mae Diary
- There is always something to worry about.
- There are always respected investors who say that you’re wrong. You have to know the story better than they do, and have faith in what you know.
- As so often happens in the stock market, several years’ worth of patience was rewarded in one.
Twenty: The Restaurant Stocks / Putting Your Money Where Your Mouth Is
- As long as Americans continue to eat 50 percent of their meals outside the home, there will be new 20-baggers showing up in the food courts at the malls and in our neighborhoods, and the observant diner will be able to spot them.
Twenty-One: The Six-Month Checkup
- A healthy portfolio requires a regular checkup—perhaps every six months or so.
20 Golden Rules
- Your investor’s edge is not something you get from Wall Street experts. It’s something you already have. You can outperform the experts if you use your edge by investing in companies or industries you already understand.
- Over the past three decades, the stock market has come to be dominated by a herd of professional investors. Contrary to popular belief, this makes it easier for the amateur investor. You can beat the market by ignoring the herd.
- Often there is no correlation between the success of a company’s operations and the success of its stock over a few months or even a few years. In the long term, there is a 100 percent correlation between the success of the company and the success of its stock. This disparity is the key to making money; it pays to be patient, and to own successful companies.
- You have to know what you own, and why you own it. “This baby is a cinch to go up!” doesn’t count.
- Long shots almost always miss the mark.
- Owning stocks is like having children—don’t get involved with more than you can handle. The part-time stockpicker probably has time to follow 8-12 companies, and to buy and sell shares as conditions warrant. There don’t have to be more than 5 companies in the portfolio at any one time.
- If you can’t find any companies that you think are attractive, put your money in the bank until you discover some.
- Never invest in a company without understanding its finances. The biggest losses in stocks come from companies with poor balance sheets.
- Avoid hot stocks in hot industries. Great companies in cold, non growth industries are consistent big winners.
- With small companies, you’re better off to wait until they turn a profit before you invest.
- If you invest $1,000 in a stock, all you can lose is $1,000, but you stand to gain $10,000 or even $50,000 over time if you’re patient. You need to find only a few good stocks to make a lifetime of investing worthwhile.
- In every industry and every region of the country, the observant amateur can find great growth companies long before the professionals have discovered them.
- A stock-market decline is as routine as a January blizzard in Colorado. If you’re prepared, it can’t hurt you. A decline is a great opportunity to pick up the bargains left behind by investors who are fleeing the storm in panic.
- Everyone has the brainpower to make money in stocks. Not everyone has the stomach. If you are susceptible to selling everything in a panic, you ought to avoid socks and stock mutual funds altogether.
- There is always something to worry about. Avoid weekend thinking and ignore the latest dire predictions of newscasters. Sell a stock because the company’s fundamentals deteriorate, not because the sky is falling.
- Nobody can predict interest rates, the future direction of the economy, or the stock market. Dismiss all such forecasts and concentrate on what’s actually happening to the companies in which you’ve invested.
- If you study 10 companies, you’ll find 1 for which the story is better than expected. If you study 50, you’ll find 5. There are always pleasant surprises to be found in the stock market—companies whose achievements are being overlooked on Wall Street.
- If you don’t study any companies you have the same chance of success buying stocks as you do in a poker game if you bet without looking at your cards.
- Time is on your side when you own shares of superior companies. You can afford to be patient—even if you missed Wal-Mart in the first five years, it was a great stock to own in the next five years. Time is against you when you own options.
- In the long run, a portfolio of well-chosen stocks will always outperform a portfolio of bonds or a money-market account. In the long run, a portfolio of poorly chosen stocks won’t outperform the money left under the mattress.