Chasing 10-baggers: The Timeless Wisdom of Peter Lynch

Right up there with Warren Buffett, Howard Marks, Joel Greenblatt, Ray Dalio, and others, Peter Lynch holds a steadfast position in the hall of fame for investors. Many of these prominent investors draw parallels to each other; however, Peter Lynch has several unique perspectives. In this article, we'll go through some standout quotes from One Up On Wall Street and other highly valuable observations from the book. Whether you're a seasoned investor or just starting out, these insights will challenge your thinking and inspire your strategy. Let's dive right in and discover what sets Peter Lynch apart.

• Amateurs can outperform professionals: Lynch believes that ordinary investors can achieve high returns similar to, or even better than, professional asset managers.

• Value of writing: By clearly defining and writing down one's investment thesis, investors can stay focused on their goals and avoid being swayed by transient market information or trends.

• Focus on high-growth and niche companies: His investment approach prioritizes fast-growing companies with competitive advantages and niches.

• Simplicity: Lynch champions simplicity in investing, favoring straightforward and understandable investments.

Let's begin by debunking the misconceptions surrounding Lynch's boots-on-the-ground research process. His own disclaimer states:

Lynch doesn't advocate for investors to base investment decisions purely on an instinctive perception of a product or service. He also doesn't suggest that investors should blindly trust their taste buds when shaping their portfolios. Instead, his message emphasizes that investors can draw from their existing knowledge or strengths as inspiration for identifying potential portfolio additions.

The central message of One Up On Wall Street can be distilled as follows: There's a distinction between being a good fund manager and a good investor. However, more crucially, amateurs stand an equally strong chance of achieving high returns as their professional counterparts. This belief arises from three primary observations:

1. The prevailing incentive structure surrounding fund managers.

2. Professional investors' hesitance or incapacity to acknowledge their limitations or gaps in expertise.

3. According to Lynch, the stomach is a more important organ than the brain when it comes to achieving success on the stock market.

Lynch argues that the incentive structure for fund managers prioritizes short-term results. This not only inhibits long-term success but also frequently leads to herd behavior and irrational decision-making. Moreover, Lynch believes that the absence of prestige and the presence of humility are valuable qualities for investors. However, these qualities are unfortunately not particularly compatible with climbing the social hierarchy or impressing one's boss. Private investors don't have to face these constraints and therefore aren't slowed down by them. The stomach, in this case, is of course a metaphor for mood and temperament. Two more quotes that emphasize the above:

The fact that information has been completely democratized over the past 30 years is worth reflecting on. In many ways, it made sense for Lynch, just as Warren Buffett did early in his career, to look for companies that had not yet been found by institutional investors. Buffett took this to the extreme and actually looked for junk – which could be bought for less than it was worth – because no one was looking.

Buffett's first decade on the stock market was largely characterized by this. Buffett himself often uses the cigar butt metaphor, which he coined in Berkshire Hathaway's 1989 letter to shareholders. The metaphor illustrates an investment where the investor is looking for cigar butts on the street (companies no one wants), with one last "puff" in it. The given observation here is that it has likely become harder over time to find cigar butts and massive mispricings as information has become more democratized and accessible.

By studying Buffett and his investments over the years, one can discern a pattern based on him gradually focusing more on quality and less on price over time. However, this shift is most likely a result of the constantly and rapidly growing portfolio volume, which forces him to invest in larger companies. Also, Buffett met his right-hand man in 1959, Charlie Munger, who influenced him to buy "compounders" instead of cigar butts. Today we see companies such as Apple, Amazon, StoneCo, Visa, and Snowflake in Berkshire Hathaway's portfolio. Pretty much the furthest from cigar butts one can get in other words. With that said, back to Lynch.

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Lynch ended up selling Warner just six months later at $38, only to see its value soar to $180 a few years down the line. On the topic of democratization of information, closely aligned with increased accessibility, this anecdote becomes particularly relevant. While increased access to information brings benefits, it isn't without pitfalls. Everyone who has read Daniel Kahneman knows that Homo Sapiens, meaning both you and me, are riddled with endless cognitive biases that continually cloud our judgment. It is reasonable to assume that the availability of information hardly makes us less affected by these biases.

Imagine this: you buy a stock based on fundamental analysis, then react to macro-related news, and ultimately sell the whole position based on technical analysis. This process is clearly insufficient – especially if your initial thesis was solely grounded in fundamental analysis. It's even more concerning if you sell based on a recommendation from someone whose identity, track record, or incentives you're unaware of; just like Lynch did in the example above. Even the best of us can evidently fall into this trap.

The difficulty for investors to navigate the investment landscape in an environment where all the world's information is constantly within reach in their pocket is also evident by the fact that the average holding time of a stock has gone from seven years in the 1960s to today's six months. This is however of course not exclusively a function of the democratization of information. Trading has also become considerably more accessible over the same period as you now also have your broker in your pocket, and so on.

Building on the above, one can assume that as an investor, you enhance your chances of yielding high returns by clearly defining and documenting your investment strategy. This not only helps crystallize which variables you deem most impactful and worthy of focus but also safeguards against acting on emotions or instinct, and relying solely on memory. If you don't write down your strategy, it will be more exposed to cognitive biases, as your brain will unconsciously make small adjustments to it over time. You are also at greater risk of gradually and unconsciously losing your strategy or investment theses among all the headlines in the Wall Street Journal or on social media.

In short, writing helps create a thread in the train of thought and prevents one from losing convictions and the arguments behind an investment strategy or individual investments. It is simply more reasonable to trust Apple's iCloud storage more than your hippocampus.

Finally, isn't it a privilege to revisit the reasons behind investment decisions, especially during moments of doubt, which are frequent for every investor? Reflecting on written justifications for selling a stock should also mitigate the creeping FOMO that arises if it rises post-sale.

In summary, craft your investment filter and commit it to paper. This will anchor your focus on companies over events like presidential elections and ensure you maintain your course even when the herd veers elsewhere. Writing is thinking, and writing has a lot of benefits – at least Peter Lynch believed so.

Lynch had an undeniable passion for growth, but what stands out the most in his growth-focused quotes are perhaps the figures he cites. For instance, Lynch points out that some fast-growers achieve an annual growth of 20 – 30%; this statement should drop a few jaws. Investors of today are truly fortunate to be in the early stages of the internet era and digitization since we now see growth rates like this spanning over a decade or even more. Anyway, Lynch preferred to invest in growth companies, driven in part by the compelling math of exponential growth. Here's a glimpse of what various annual growth rates yield over a decade:

10% per year – 160%

20% per year – 520%

30% per year – 1280%

40% per year – 2800%

Many companies today can grow at rates previously unseen, thanks to game-changing shifts from analog to digital distribution and globalization. This landscape likely means fewer but bigger winners. Ultimately, the emphasis should gradually shift from buying at the right price to buying the right company (even if price will always be crucial). Often, the right company is determined by its revenue growth and how long it can be sustained, a belief Peter Lynch certainly held.

These quotes bring companies such as Copart, Alphabet, and Visa to mind. It's not due to any stagnation in their respective industries (as with Philip Morris), but rather because few companies enjoy such gracious competitive positions as these. One of Lynch's core ideas is not only to focus on the quality of a company, but also on the relative quality and superiority it has over its competition. In short: it is often better to focus on a company's competitive advantage and position rather than just the quality of the business.

Lynch elaborates on this by underscoring the value of occupying a niche, drawing a comparison between Xerox and Philip Morris. While Philip Morris is a renowned American tobacco company dealing in cigarettes and other tobacco products in an industry with negative growth, Xerox operated in a booming market but competed with giants like Apple. As for shareholder returns since Lynch wrote about this in One Up On Wall Street, Philip Morris has absolutely crushed Xerox.

The takeaway here is clear: A mediocre company in a struggling industry can thrive if the competitive environment is favorable. Conversely, even a standout company in a booming sector might not outperform if faced with fierce competition. Essentially, a company's success is determined as much about its competitive position as its intrinsic capabilities.

To summarize Lynch's investment approach: Focus on high-growth, niche companies where management possesses substantial insider ownership. Ideally, invest in a stock before it captures the attention of institutional investors. Concentrate on understanding the essence of the companies, their growth prospects, and competitive positions. Don't try to time the market and avoid making investment decisions based on macro variables or personal preferences. Most importantly, embrace simplicity, maintain humility, and never underestimate common sense.

”The bearish argument always sounds more intelligent.” (p. 23)

“It’s self-defeating to try to invest in good markets and get out of bad ones.” (p. 48)

“Obviously you don’t have to be able to predict the stock market to make money in stocks, or else I wouldn’t have made any money.” (p. 84)

“If professionals can’t predict economies and professional forecasters can’t predict markets, then what chance does the amateur investor have?” (p. 87)

“No wonder why people make money in the real estate market and lose money in the stock market. They spend months choosing their houses, and minutes choosing their stocks. In fact, they spend more time shopping for a good microwave oven than shopping for a good investment.” (p. 80)

”The simpler it is, the better I like it.” (p. 130).

“Why take chances on a fickle purchase when there’s so much steady business around?” (p. 142)

“When management owns stock, then rewarding the shareholders becomes a first priority, whereas when management simply collects a paycheck, then increasing salaries becomes a first priority.” (p. 143)

“Insider selling usually means nothing and it’s silly to react to it. There are many reasons that officers might sell. But there’s only one reason that insiders buy.” (p. 144)

“Wait for the earnings. You can get tenbaggers in companies that have already proven themselves. When in doubt, tune in later.” (p. 159)

“Value always wins out – or at least in enough cases that it’s worthwhile to believe it.” (p. 161)

“Once you’re able to tell the story of a stock to your family, your friends, or the dog, and so that even a child could understand it, then you have a proper grasp of the situation.” (p. 175)

“La Quinta was a great story, and not one of those would-be, could-be, might-be, soon-to-be tales. If they aren’t already doing it, then don’t invest in it.” (p. 179)

“It’s never too late not to invest in an unproven enterprise.” (p. 182)

“All else being equal, a 20-percent grower selling at 20 times earnings is a much better buy than a 10-percent grower selling at 10 times earnings.” (p. 218)

“All of this research I’ve been talking about takes a couple of hours, at most, for each stock.” (p. 227)

“What’s wrong with high expectations? If you expect to make 30 percent year after year, you’re most likely to get frustrated at stocks for defying you.” (p. 237)

“Going into cash would be getting out of the market. My idea is to stay in the market forever, and to rotate stocks depending on the fundamental situation.” (p. 242)

“Sell the winners and hold on to the losers is as sensible as pulling out the flowers and watering the weeds.” (p. 243)

“Most money I make is in the third or fourth year that I’ve owned something.” (p. 266)

“In most cases it’s better to buy the original good company at a high price than it is to jump on the ‘next one’ at a bargain price.” (p. 268)

“It takes years, not months, to produce big results.” (p. 285)

“Just because the price goes up doesn’t mean you’re right.” (p. 286)

“Buying a company with mediocre prospects just because the stock is cheap is a losing technique.” (p. 286)

“You don’t have to kiss all the girls. I’ve missed my share of tenbaggers and it hasn’t kept me from beating the market.” (p. 286)