One Up On Wall Street
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One Up On Wall Street

How To Use What You Already Know To Make Money In

Peter Lynch, John Rothchild

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eBook - ePub

One Up On Wall Street

How To Use What You Already Know To Make Money In

Peter Lynch, John Rothchild

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About This Book

More than one million copies have been sold of this seminal book on investing in which legendary mutual-fund manager Peter Lynch explains the advantages that average investors have over professionals and how they can use these advantages to achieve financial success. America's most successful money manager tells how average investors can beat the pros by using what they know. According to Lynch, investment opportunities are everywhere. From the supermarket to the workplace, we encounter products and services all day long. By paying attention to the best ones, we can find companies in which to invest before the professional analysts discover them. When investors get in early, they can find the "tenbaggers, " the stocks that appreciate tenfold from the initial investment. A few tenbaggers will turn an average stock portfolio into a star performer. Lynch offers easy-to-follow advice for sorting out the long shots from the no-shots by reviewing a company's financial statements and knowing which numbers really count. He offers guidelines for investing in cyclical, turnaround, and fast-growing companies. As long as you invest for the long term, Lynch says, your portfolio can reward you. This timeless advice has made One Up on Wall Street a #1 bestseller and a classic book of investment know-how.

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Year
2012
ISBN
9781439126158

Part I

PREPARING TO INVEST

Before you think about buying stocks, you ought to have made some basic decisions about the market, about how much you trust corporate America, about whether you need to invest in stocks and what you expect to get out of them, about whether you are a short-or long-term investor, and about how you will react to sudden, unexpected, and severe drops in price. It’s best to define your objectives and clarify your attitudes (do I really think stocks are riskier than bonds?) beforehand, because if you are undecided and lack conviction, then you are a potential market victim, who abandons all hope and reason at the worst moment and sells out at a loss. It is personal preparation, as much as knowledge and research, that distinguishes the successful stockpicker from the chronic loser. Ultimately it is not the stock market nor even the companies themselves that determine an investor’s fate. It is the investor.

1

The Making of a Stockpicker

There’s no such thing as a hereditary knack for picking stocks. Though many would like to blame their losses on some inbred tragic flaw, believing somehow that others are just born to invest, my own history refutes it. There was no ticker tape above my cradle, nor did I teethe on the stock pages in the precocious way that baby PelĂ© supposedly bounced a soccer ball. As far as I know, my father never left the pacing area to check on the price of General Motors, nor did my mother ask about the ATT dividend between contractions.
Only in hindsight can I report that the Dow Jones industrial average was down on January 19, 1944, the day I was born, and declined further the week I was in the hospital. Though I couldn’t have suspected it then, this was the earliest example of the Lynch Law at work. The Lynch Law, closely related to the Peter Principle, states: Whenever Lynch advances, the market declines. (The latest proof came in the summer of 1987, when just after the publisher and I reached an agreement to produce this book, a high point in my career, the market lost 1,000 points in two months. I’ll think twice before attempting to sell the movie rights.)
Most of my relatives distrusted the stock market, and with good reason. My mother was the youngest of seven children, which meant that my aunts and uncles were old enough to have reached adulthood during the Great Depression, and to have had firsthand knowledge of the Crash of ’29. Nobody was recommending stocks around our household.
The only stock purchase I ever heard about was the time my grandfather, Gene Griffin, bought Cities Service. He was a very conservative investor, and he chose Cities Service because he thought it was a water utility. When he took a trip to New York and discovered it was an oil company, he sold immediately. Cities Service went up fiftyfold after that.
Distrust of stocks was the prevailing American attitude throughout the 1950s and into the 1960s, when the market tripled and then doubled again. This period of my childhood, and not the recent 1980s, was truly the greatest bull market in history, but to hear it from my uncles, you’d have thought it was the craps game behind the pool hall. “Never get involved in the market,” people warned. “It’s too risky. You’ll lose all your money.”
Looking back on it, I realize there was less risk of losing all one’s money in the stock market of the 1950s than at any time before or since. This taught me not only that it’s difficult to predict markets, but also that small investors tend to be pessimistic and optimistic at precisely the wrong times, so it’s self-defeating to try to invest in good markets and get out of bad ones.
My father, an industrious man and former mathematics professor who left academia to become the youngest senior auditor at John Hancock, got sick when I was seven and died of brain cancer when I was ten. This tragedy resulted in my mother’s having to go to work (at Ludlow Manufacturing, later acquired by Tyco Labs), and I decided to help out by getting a part-time job myself. At the age of eleven I was hired as a caddy. That was on July 7, 1955, a day the Dow Jones fell from 467 to 460.
To an eleven-year-old who’d already discovered golf, caddying was an ideal occupation. They paid me for walking around a golf course. In one afternoon I would outearn delivery boys who tossed newspapers onto lawns at six A.M. for seven days in a row. What could be better than that?
In high school I began to understand the subtler and more important advantages of caddying, especially at an exclusive club such as Brae Burn, outside of Boston. My clients were the presidents and CEOs of major corporations: Gillette, Polaroid, and more to the point, Fidelity. In helping D. George Sullivan find his ball, I was helping myself find a career. I’m not the only caddy who learned that the quickest route to the boardroom was through the locker room of a club like Brae Burn.
If you wanted an education in stocks, the golf course was the next best thing to being on the floor of a major exchange. Especially after they’d sliced or hooked a drive, club members enthusiastically described their latest triumphant investment. In a single round of play I might give out five golf tips and get back five stock tips in return.
Though I had no funds to invest in stock tips, the happy stories I heard on the fairways made me rethink the family position that the stock market was a place to lose money. Many of my clients actually seemed to have made money in the stock market, and some of the positive evidence actually trickled down to me.
A caddy quickly learns to sort his golfers into a caste system, beginning with the rare demigods (great golfer, great person, great tipper), moving down through the so-so golfers and so-so tippers, and eventually hitting bottom with the terrible golfer, terrible person, terrible tipper—a dreaded untouchable of the links. Mostly I caddied for average golfers and average spenders, but if it came down to a choice between a bad round with a big tipper, or a great round with a bad tipper, I learned to opt for the former. Caddying reinforced the notion that it helps to have money.
I continued to caddy throughout high school and into Boston College, where the Francis Ouimet Caddy Scholarship helped pay the bills. In college, except for the obligatory courses, I avoided science, math, and accounting—all the normal preparations for business. I was on the arts side of school, and along with the usual history, psychology, and political science, I also studied metaphysics, epistemology, logic, religion, and the philosophy of the ancient Greeks.
As I look back on it now, it’s obvious that studying history and philosophy was much better preparation for the stock market than, say, studying statistics. Investing in stocks is an art, not a science, and people who’ve been trained to rigidly quantify everything have a big disadvantage. If stockpicking could be quantified, you could rent time on the nearest Cray computer and make a fortune. But it doesn’t work that way. All the math you need in the stock market (Chrysler’s got $1 billion in cash, $500 million in long-term debt, etc.) you get in the fourth grade.
Logic is the subject that’s helped me the most in picking stocks, if only because it taught me to identify the peculiar illogic of Wall Street. Actually Wall Street thinks just as the Greeks did. The early Greeks used to sit around for days and debate how many teeth a horse has. They thought they could figure it out by just sitting there, instead of checking the horse. A lot of investors sit around and debate whether a stock is going up, as if the financial muse will give them the answer, instead of checking the company.
In centuries past, people hearing the rooster crow as the sun came up decided that the crowing caused the sunrise. It sounds silly now, but every day the experts confuse cause and effect on Wall Street in offering some new explanation for why the market goes up: hemlines are up, a certain conference wins the Super Bowl, the Japanese are unhappy, a trendline has been broken, Republicans will win the election, stocks are “oversold,” etc. When I hear theories like these, I always remember the rooster.
In 1963, my sophomore year in college, I bought my first stock—Flying Tiger Airlines for $7 a share. Between the caddying and a scholarship I’d covered my tuition, living at home reduced my other expenses, and I had already upgraded myself from an $85 car to a $150 car. After all the tips that I’d had to ignore, I finally was rich enough to invest!
Flying Tiger was no wild guess. I picked it on the basis of some dogged research into a faulty premise. In one of my classes I’d read an article on the promising future of air freight, and it said that Flying Tiger was an air freight company. That’s why I bought the stock, but that’s not why the stock went up. It went up because we got into the Vietnam War and Flying Tiger made a fortune shunting troops and cargo in and out of the Pacific.
In less than two years Flying Tiger hit $323/4 and I had my first fivebagger. Little by little I sold it off to pay for graduate school. I went to Wharton on a partial Flying Tiger scholarship.
If your first stock is as important to your future in finance as your first love is to your future in romance, then the Flying Tiger pick was a very lucky thing. It proved to me that the big-baggers existed, and I was sure there were more of them from where this one had come.
During my senior year at Boston College I applied for a summer job at Fidelity, at the suggestion of Mr. Sullivan, the president—the hapless golfer, great guy, and good tipper for whom I’d caddied. Fidelity was the New York Yacht Club, the Augusta National, the Carnegie Hall, and the Kentucky Derby. It was the Cluny of investment houses, and like that great medieval abbey to which monks were flattered to be called, what devotee of balance sheets didn’t dream of working here? There were one hundred applications for three summer positions.
Fidelity had done such a good job selling America on mutual funds that even my mother was putting $100 a month into Fidelity Capital. That fund, run by Gerry Tsai, was one of the two famous go-go funds of this famous go-go era. The other was Fidelity Trend, run by Edward C. Johnson III, also known as Ned. Ned Johnson was the son of the fabled Edward C. Johnson II, also known as Mister Johnson, who founded the company.
Ned Johnson’s Fidelity Trend and Gerry Tsai’s Fidelity Capital outperformed the competition by a big margin and were the envy of the industry over the period from 1958 to 1965. With these sorts of people training and supporting me, I felt as if I understood what Isaac Newton was talking about when he said: “If I have seen further . . . it is by standing upon the shoulders of Giants.”
Long before Ned’s great successes, his father, Mister Johnson, had changed America’s mind about investing in stocks. Mister Johnson believed that you invest in stocks not to preserve capital, but to make money. Then you take your profits and invest in more stocks, and make even more money. “Stocks you trade, it’s wives you’re stuck with,” said the always quotable Mister Johnson. He wouldn’t have won any awards from Ms. magazine.
I was thrilled to be hired at Fidelity, and also to be installed in Gerry Tsai’s old office, after Tsai had departed for the Manhattan Fund in New York. Of course the Dow Jones industrials, at 925 when I reported for work the first week of May, 1966, had fallen below 800 by the time I headed off to graduate school in September, just as the Lynch Law would have predicted.

RANDOM WALK AND MAINE SUGAR

Summer interns such as me, with no experience in corporate finance or accounting, were put to work researching companies and writing reports, the same as the regular analysts. The whole intimidating business was suddenly demystified—even liberal arts majors could analyze a stock. I was assigned to the paper and publishing industry and set out across the country to visit companies such as Sorg Paper and International Textbook. Since the airlines were on strike, I traveled by bus. By the end of the summer the company I knew most about was Greyhound.
After that interlude at Fidelity, I returned to Wharton for my second year of graduate school more skeptical than ever about the value of academic stock-market theory. It seemed to me that most of what I learned at Wharton, which was supposed to help you succeed in the investment business, could only help you fail. I studied statistics, advanced calculus, and quantitative analysis. Quantitative analysis taught me that the things I saw happening at Fidelity couldn’t really be happening.
I also found it difficult to integrate the efficient-market hypothesis (that everything in the stock market is “known” and prices are always “rational”) with the random-walk hypothesis (that the ups and downs of the market are irrational and entirely unpredictable). Already I’d seen enough odd fluctuations to doubt the rational part, and the success of the great Fidelity fund managers was hardly unpredictable.
It also was obvious that Wharton professors who believed in quantum analysis and random walk weren’t doing nearly as well as my new colleagues at Fidelity, so between theory and practice, I cast my lot with the practitioners. It’s very hard to support the popular academic theory that the market is irrational when you know somebody who just made a twentyfold profit in Kentucky Fried Chicken, and furthermore, who explained in advance why the stock was going to rise. My distrust of theorizers and prognosticators continues to the present day.
Some Wharton courses were rewarding, but even if they’d all been worthless, the experience would have been worth it, because I met Carolyn on the campus. (We got married while I was in the Army, on May 11, 1968, a Saturday when the market was closed, and we had a week-long honeymoon during which the Dow Jones lost 13.93 points—not that I was paying attention. This is something I looked up later.)
After finishing that second year at Wharton, I reported to the Army to serve my two-year hitch required under the ROTC program. From 1967 to 1969, I was a lieutenant in the artillery, sent first to Texas and later to Korea—a comforting assignment considering the alternative. Lieutenants in the artillery mostly wound up in Vietnam. The only drawback to Korea was that it was far away from the stock exchange, and as far as I knew, there was no stock market in Seoul. By this time I was suffering from Wall Street withdrawal.
I made up for lost time during infrequent leaves, when I’d rush home to buy the various hot stocks that friends and colleagues recommended. They were buying high-flying issues that kept going up, but for me they suggested conservative issues that kept going down. Actually I made some money in Ranger Oil, but I lost more in Maine Sugar, a sure-win situation that flopped.
The Maine Sugar people had gone around to all the Maine potato farmers to convince them to grow sugar beets in the off-season. This was going to be extremely profitable for Maine Sugar, not to mention for the Maine farmers. By planting the sugar beets—the perfect companion crop to potatoes—farmers could make extra money and revitalize the soil at the same time. Moreover, Maine Sugar was footing the bill for planting the beets. All the farmers had to do was haul the grown-up beets to the huge new refinery that Maine Sugar had just built.
The hitch was that these were Maine farmers, and Maine farmers are very cautious. Instead of planting hundreds of acres of sugar beets, the first year they tried it on a quarter acre, and then when that worked, they expanded to a half acre, and by the time they got to a full acre, the refinery was shut for lack of business and Maine Sugar went bankrupt. The stock fell to six cents, so one share could buy you six gumballs from a Lions Club machine.
After the Maine Sugar fiasco I vowed never to buy another stock that depended on Maine farmers’ chasing after a quick buck.
I returned from Korea in 1969, rejoined Fidelity as a permanent employee and research analyst, and the stock market promptly plummeted. (Lynch Law theorists take note.) In June of 1974, I was promoted from assistant director of research to director of research, and the Dow Jones lost 250 points in the next three months. In May of 1977, I took over the Fidelity Magellan fund. The market stood at 899 and promptly began a five-month slide to 801.
Fidelity Magellan had $20 million in assets....

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