One Up on Wall Street: How to Use What You Already Know to Make Money in the Market

The summary

The professionals are not hiding anything from you. That’s the claim underneath everything in this book, and Peter Lynch earned the right to make it. He ran Fidelity’s Magellan Fund from May 1977 to May 1990, and Fidelity’s own records show it going from $20 million in assets to the $14 billion his successor inherited; a thousand dollars left in the fund across those thirteen years came out as twenty-eight thousand. His account of how is deflating. No macro forecast, no model — he looked at more companies than anyone else was willing to, and found a good many of the best ones the way you would, as a customer in a store.

Your edge is wherever you already stand

Count the people who watch a successful company up close: its employees, its suppliers, the contractors building its new stores, the customers in the queue. All of them see the business working months before it reaches an analyst’s note, and Lynch’s complaint is that they trade the knowledge away. The doctors prescribing a new ulcer drug were, he suspected, fully invested in oil stocks while the oil executives bought drug issues — each group spending its edge in the other’s field.

His own best example arrived in a grocery bag. His wife Carolyn brought home a pair of L’eggs pantyhose from a test market and said they were good. He did the work: women went to the supermarket weekly and a department store every six weeks, and all the decent hosiery was being sold in the wrong place. Hanes became his largest position. When a rival landed on the same rack, he bought 48 pairs and handed them round the office; the verdict came back in a fortnight — not as good — so he held on. He called that fundamental research, and he meant it literally.

The line everyone quotes and the sentence they skip

Writing a new introduction eleven years on, Lynch was tired enough of being misread to print a disclaimer. Liking a store, a product or a restaurant is a good reason to put a company on your research list. It is not a reason to own it. A busy Dunkin’ Donuts is an anonymous tip shoved through the letterbox — intriguing, unverified, worth nothing until you’ve checked earnings prospects, financial condition and competitive position.

Two of those checks do most of the work. The first is size: a company already worth $39 billion and earning $3 billion a year, as General Electric was, can’t grow those numbers quickly, however good its products. The second is which inning the story is in — a retailer with stores in 10 percent of the country is a different proposition from the same retailer at 90 percent, and the share price rarely tells them apart. Beyond that he tracked one number, earnings. The stock price he thought the least useful information anyone follows, and the most followed.

Six kinds of story

Judging a company starts with knowing what kind it is, because each kind pays out differently:

• Slow growers — large, aging, flat. You own them for the dividend.
• Stalwarts — multibillion-dollar hulks compounding earnings around 10 to 12 percent. Lynch took a 30 to 50 percent gain and moved on, keeping a few as ballast through slumps.
• Fast growers — small and aggressive, growing 20 to 25 percent a year. Where the tenbaggers live, and best of all in a slow industry.
• Cyclicals — autos, airlines, steel. The most misunderstood, because they look like stalwarts and can halve if you buy at the wrong point in the cycle.
• Turnarounds — battered companies that rebound fast if they survive, largely detached from the market.
• Asset plays — something valuable on the books that the market hasn’t priced in.

The categories aren’t a filing system, they’re a set of expectations: you don’t hold a stalwart waiting for a tenfold gain. Companies migrate, too — a fast grower runs out of room, becomes a stalwart, and ends up a candidate for a turnaround.

The tension he doesn’t resolve

None of this survives contact with The Little Book of Common Sense Investing intact. Bogle’s arithmetic says investors as a group earn the market’s return minus costs, so the average stock-picker must trail it — and Lynch half-concedes it. Writing at the end of the nineties, he noted that money had poured into mutual funds through the greatest bull market on record and drew the obvious conclusion: if amateurs had done well picking their own stocks, they wouldn’t have migrated. Their method must be flawed. His reply isn’t that stock-picking is easy, only that it’s work, and that most people do more homework on a refrigerator than on a $10,000 position.

Where the two camps stop arguing is temperament. From 1965 to 1995, by Lynch’s arithmetic, a saint who bought at the low of every single year compounded at 11.7 percent; the unluckiest soul alive, buying at the high thirty years running, got 10.6. Three decades of perfect timing bought about a point a year. Declines are the entry fee — 53 drops of 10 percent or more in 95 years, 15 of them 25 percent or worse — which is why he said the key organ in this business is the stomach, not the brain.

The bottom line

The market rewards people who understand what they own, and that understanding is open to anyone willing to do the reading — but the reading is the whole thing, not the noticing. Lynch’s examples are period pieces now and were never the point; the method was, and the method is checking a hunch until it becomes a case. Read it if you intend to pick individual stocks and want an honest account of the work involved. If you’d rather skip that work, the book’s own logic hands you back to an index fund.