Beating the Street Redux

I recently re-read Peter Lynch’s One Up on Wall Street to see how it stood against the test of time. One Up was written in 1989 and was an instant hit in large part because Lynch was the successful manager of one of the largest mutual funds in the market—Fidelity Investment’s Magellan Fund.

Many have the impression that Lynch was a rarity: a portfolio manager who did not espouse a value investing philosophy but who consistently beat the market anyway. If that were true, it would mean there were two such investors in recent history: Lynch and Soros. But upon closer inspection, I think we have to scratch Lynch from that rare list. Lynch was a practicing value investor and his bows to value investors such as Buffett, Max Heine, Michael Price, and John Neff and his many references to Ben Graham’s “Mr. Market” are testament to that. There is also this:

Lynch’s Perfect Investment

Lynch wrote thirteen bullet points to describe his perfect investment. I will not fill in Lynch’s details because his headings are self-explanatory; you can read the details at your leisure:

  1. It sounds dull—or even better, ridiculous
  2. It does something dull
  3. It does something disagreeable
  4. It’s a spinoff
  5. The institutions don’t own it, and the analysts don’t follow it
  6. The rumors abound: It’s involved with toxic waste and/or the Mafia
  7. There’s something depressing about it
  8. It’s a no-growth industry
  9. It’s got a niche
  10. People have to keep buying (their product)
  11. It’s a user of technology
  12. The insiders are buyers
  13. The company is buying back shares

Clearly, this is a list that Buffett would love. The first eight items on the list imply that the stock’s price will be low relative to fundamentals. Lynch was a bottom up investor who selected value securities to buy in all market environments. He thought it silly to buy or sell a security solely because of a view of what was happening in the market.

When we think of great value investors, why doesn’t Lynch immediately come to mind? 1. Perhaps it was because he did not call himself a value investor, but then again, neither did Ben Graham. 2. Perhaps it was the size of his fund. We tend to think of value funds as small funds and Magellan’s outperformance was remarkable given its size. But Magellan wasn’t always a multi-billion dollar powerhouse. When Lynch took over in 1977, Magellan had only $20 million in assets under management. It was Lynch’s success—because he was a true value investor—that led to the explosion in the size of the Magellan Fund. 3. Perhaps it was the number of companies he owned after the fund grew: he bragged of owning 1,400 companies and the running joke on Wall Street was that Lynch never met a stock he didn’t like. Buffett and many other value investors believe that it is crazy to put your money in your fiftieth-best idea, and they concentrate their portfolios in a few dozen names at most. We also know that there were stocks that Lynch did not like:

“If I could avoid a single stock, it would be the hottest stock in the hottest industry, the one that gets the most favorable publicity, the one that every investor hears about in the car pool or on the commuter train—and succumbing to the social pressure, often buys.”

In fact, the main theme of One Up on Wall Street is that behaving contrary to the “smart money” is good for your financial health. And, what is more contrarian than value investing?

Lynch thinks that the individual investor has a huge advantage over the professional investors on Wall Street who 1. have to put billions of dollars to work; 2. have to answer to investment committees; 3. are incentivized to invest like every other professional on Wall Street and threatened with job loss if they don’t; and 4. have to plan for daily redemption requests. The individual investor does not have to deal with any of that and so she can focus all of her effort on finding bargains and holding them until the rest of the market catches up. Of course, that also means that the individual investor has to be able to read a financial statement and put in the hours and effort to find these bargains.

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