One Up On Wall Street: Peter Lynch's Investment Philosophy

The book I value the most in my possession, closely followed by "Fooled by Randomness", is "One Up On Wall Street", written by the legendary Peter Lynch. I nearly used up a whole highlighter when I read the book for the second time. There's thus hardly a single spread in the book that remains black and white. In this article, I'll go through some of my favorite quotes from One Up On Wall Street and other observations from the book that I find highly valuable. Let's dive right in.

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 capital allocation 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.

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In my view, 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 securing high returns as their professional counterparts. This belief, as I interpret it, arises from three primary observations:

1. The prevailing incentive structure surrounding fund managers.

2. The 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 surrounding fund managers prioritizes short-term results, which not only inhibits long-term success but also frequently leads to herd behavior. Moreover, Lynch believes that lack of prestige and humility are both valuable qualities for investors, but they are unfortunately not particularly compatible with climbing within the social hierarchy or impressing one's boss. Private investors don't have to endure these constructions and therefore aren't slowed down by them. The stomach, in this case, is of course a metaphor for mood and temperament. Here are 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, as 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 exchange was largely characterized by this. Buffett himself 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 and what should be prioritized to store in your brain 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. Back to Lynch.

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. As we delve into the democratization of information, this anecdote becomes particularly relevant. While increased access to information brings benefits, it isn't without its 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. I believe that the availability of information hardly makes us less affected by these biases.

I believe that if you buy a stock based on fundamental analysis, then react to macro-related news, and ultimately sell the whole position based on technical analysis, the outcome is rarely favorable—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 clearly 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, 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, I firmly believe 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 relying solely on memory. If you don't write down your strategy, it should be more exposed to cognitive biases as your brain will unconsciously make small adjustments, specifically all the time. Furthermore, you are at greater risk of gradually and unconsciously losing your strategy among all the headlines in the Wall Street Journal or on Twitter/X.

My perception is that writing helps me create a thread in my train of thought. I also feel that writing partially prevents me from losing my convictions and the arguments behind my investment strategy and individual investments. I simply trust Apple's iCloud storage more than my hippocampus.

Finally, I consider it a privilege to revisit the reasons behind my investment decisions, especially during moments of doubt, which are frequent. Reflecting on written justifications for selling a company often mitigates the creeping FOMO that arises when a stock 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.

Lynch had an undeniable passion for growth, but what stands out in his growth-focused quotes are the figures he cites. For instance, Lynch points out that some fast-growers achieve an annual growth of 20–30%. My jaw dropped when I read this. Modern investors are truly fortunate for being 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.

Reflect on the fact that tech juggernauts haven't yet needed to spin off significant divisions like AWS, Instagram, Azure, or Alipay. Meanwhile, in a continent as advanced as Europe, the bulk of transactions are still conducted in cash. Additionally, the continent projected to boast the largest population by 2100 remains largely disconnected from the global economic and financial system.

Anyway, I prefer to invest in growth companies just like Lynch, 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%

Investments anchored in margin expansion or mispricings, those predicated on multiple expansions, have their limits. Achieving the results from the aforementioned calculations is challenging, especially in the long haul. The maximum potential of the margin variable is always constrained by current sales, and there's likely an upper limit to a company's valuation regardless of its potential. In essence, multiple expansions can't go on indefinitely.

Today's companies can grow at rates previously unseen, thanks to game-changing shifts from analog to digital distribution, globalization, and readily available venture capital. This landscape likely means fewer but bigger winners. Ultimately, the emphasis has shifted gradually from buying at the right price to buying the right company. Often, the "right" company is determined by its revenue growth, a belief Peter Lynch certainly held.

These quotes brought companies such as Evolution to mind. It's not due to any stagnation in the casino industry, but rather because few companies enjoy as gracious a competitive position as Evolution does with its monopolistic stance in the live casino market. This unique standing likely stems from the fact that the gambling sector isn't viewed favorably, primarily for ethical and moral reasons. It's doubtful that many graduates from prestigious institutions like Stanford, MIT, or Harvard aspire to revolutionize the world as creators of a live casino platform.

In 2020, Evolution acquired one of its largest competitors and increased its sales by 53%. In contrast, the next closest competitor experienced a 25% decline in revenue. There's hardly any notable competition beyond this. For Evolution, it's as if the company embodies the entire market. If, like me, you gauge a company's caliber in large part by its stance relative to competitors, then it's clear we're on the same page about Evolution's exceptionality as a company.

In One Up On Wall Street, Lynch underscores 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, Xerox, at the time, competed with giants like Apple. It's even said that Steve Jobs either drew inspiration from or outright copied Xerox when he introduced the groundbreaking mouse feature to the Macintosh. 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 stiff competition. Essentially, a company's success is as much about its competitive context 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. Understand the essence of your investment and don't try to time the market. Also, avoid making investment decisions based on macro variables or personal preferences. Most importantly, champion 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)

“I can’t imagine anything that’s useful to know that the amateur investor can’t find out.” (p. 183)

“There’s a way to get something out of an annual report in five minutes, which is all the time I spend with one.” (s. 194)

“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)