Get to know: Peter Spencer Lynch

Peter Lynch is the legendary fund manager of Fidelity’s Magellan fund, with an incredible track record of an annualized average return of 29,2 percent. He is also a bestselling author, with books seen as bibles by many investors. Whether you’re an investor or not, you can learn several life lessons from him, from an investing and a personal life standpoint.

When the successful investor, Peter Lynch, was only eleven years old, his interest in the stock market was sprung by caddying at a high-end golf club. The stock market, at the time, performed well, and as a caddy, he overheard interesting conversations daily. This led Lynch to attend Boston College, from which he graduated with a degree in finance in 1965. One year later, he got his first job in the finance industry as a summer intern at Fidelity.

An investment in the air-freight company Flying Tiger (Bought by FedEx in 1988) was one of Peter's first successful investments, the profits of which financed his master’s in business administration (MBA) from Wharton School of Business at the University of Pennsylvania.

Having caddied for Fidelity's president for over ten years, you wouldn’t be surprised that his first full-time job was at, just right, Fidelity, where he was hired as a textiles and metals analyst. In total, he stayed at Fidelity for 21 years.

The Fidelity Magellan Fund

In 1977, the 33-year-old Lynch became the manager of the aggressive capital fund Magellan fund, having mostly domestic companies in the portfolio. During his 13 years at the fund, he increased the fund's size from 18 million dollars to over 14 billion dollars, making it the world’s largest mutual fund at the time.

The average yearly return was 29,2 percent, and the fund outperformed the S&P 500 every year but two. If you had invested 1,000 dollars the day he took over the steering wheel of the fund, you would have had 28,000 dollars the day he left.

At times, Lynch held over 1,000 stocks at Magellan, using a fairly active management style,  as he frequently moved around the funds’ capital in different stocks. His success at the fund made his early retirement at only 46 years of age possible. And he says that he doesn't remember anybody when they’re dying, saying: “I wish I’d spent more time in the office.”

"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." Peter Lynch

Wisdom from Peter Lynch’s books

The legendary fund manager and bestselling author with books such as One Up on Wall Street (1989), Beating the Street (1993), and Learn to Earn (1995) is a believer in investing with a long-term approach and choosing stocks of companies whose assets are undervalued by Wall Street. You could say he’s a story investor, and each investment is based on well-grounded assumptions regarding the company's future growth.

Lynch advocates investing in what you know and companies you can understand and are familiar with the products or services of, as well as the business model and fundamentals. Thus, Lynch means that he is more likely to invest in “pantyhose rather than communications satellites” and “motel chains rather than fiber optics.”

When selecting his investments, he favors ideas that come to him, meaning no good story will be made visible through any screen or formula. He suggests investors always be on the alert for possible investment opportunities, based on their own experiences, for example, within their own business or trade, or when simply consuming different products and services.

To have reasonable expectations of the company's future, familiarize yourself with the company. Instead of predicting earnings, which Lynch is rather skeptical of, he means that you should examine the company's plans - how they intend to increase their earnings and, later on, how they execute what they’ve promised.

How a company increases its earnings

  • Reduce costs.
  • Raise prices.
  • Expand into new markets.
  • Sell more in existing markets.
  • Revitalize, close, or sell losing operations.

This takes us back to the company “story” and the company’s plan to increase earnings. How they execute this plan is simply its “story.” Your familiarity with the company and its industry will give you an edge in evaluating the firm’s strategy, abilities, and potential pitfalls.

The typical Peter Lynch company

Favorable characteristics

  • Boring name, a company is in a depressing industry
    Boring names, products, and services are often reflected in the share prices; thus, bargains can be found.
  • Spin-offs
    Often overlooked by Wall Street, according to Lynch.
  • Fastest growing company in a non-growth industry
    Growth industries attract fierce competition and many investors, leading to high prices.
  • Niche firm in a market with high entry barriers
    Complex and often of no value for competitors to enter.
  • Producer of products people buy in good and bad times
    For example, soft drinks and razor blades.
  • Low institutional ownership and analyst coverage
    Companies neglected by Wall Street aren't necessarily bad companies.
  • High insider ownership
    A positive sign that insiders are confident about the firm.
  • The company is buying back shares
    Usually performed when management sees share price as favorable, Lynch prefers share buybacks instead of expanding into unrelated businesses when companies mature and have cash flow that exceeds their capital needs.

Other factors to be examined

  • Year-by-year earnings growth: Consistent upward trends.
  • Current P/E ratio relative to historical average: In the lower span of its historical average.
  • Current P/E ratio relative to industrial average: Below the industry average.
  • Current P/E ratio relative earnings growth rate: A P/E ratio of half the level of historical earnings growth should be preferred.
  • Debt-to-equity ratio: Low debt levels relative to equity financing; bank debt is particularly bad.
  • Net cash per share: Net cash relative to share price should be high.
  • Dividends and payout ratio: Dividend investors should look for a low payout ratio (earnings per share divided by dividends per share) and preferably long track records (plus 20 years) of raised dividends.
  • Inventories: Especially for cyclical (companies that sell products or services that are in demand when the economy is doing well, for example, airlines and restaurants), if inventories build up, particularly if faster than sales, you should beware.

Lynch is actually credited with inventing the price-to-earnings-growth (PEG) ratio, which helps you, as an investor, determine whether a stock is expensive given its growth potential.

Peter Lynch’s main tips to investors

Despite his extraordinary talent in managing money and finding winning stocks, Lynch believes that the average investor has the edge over the Wall Street experts. He states, “If you stay half-alert, you can pick the spectacular performers right from your place of business or out of the neighborhood shopping mall, and long before Wall Street discovers them.” Therefore, individual investors have the advantage of looking in their everyday lives for investments, thus outperforming the experts and the overall market.