Wednesday, August 27, 2014

Book reviews: "One Up on Wall Street" and "Beating the Street" by Peter Lynch

I recently finished two books by Peter Lynch: One Up on Wall Street, his late-1980s bestseller, and Beating the Street, which he published in 1993. One Up on Wall Street explains the investment principles that Lynch used during his market-beating tenure as the manager of Fidelity's Magellan Fund. Beating the Street fleshes out these principles by providing case studies of the stocks that Lynch recommended in the 1992 Barron's roundtable.

Both books have a dangerous "stocks are always a great investment" theme. In the introduction to Beating the Street, Lynch recommends that income-seeking investors put their money in stocks, since stocks produce higher long-term returns than bonds, and generate income by selling a portion of their shares each year.

Like Warren Buffett, Lynch is a talented investor, but like Buffett, he's created a folksy public persona that misleads investors into thinking investing is simpler than it really is.

Beyond that, much of Lynch's advice is vague and contradictory. At the beginning of One Up on Wall Street, he writes: "As I’ve noted on prior occasions: 'That’s not to say there’s no such thing as an overvalued market, but there’s no point worrying about it.'"

But later he points out that:
"[I]n the late 1920s that common stocks finally reached the status of 'prudent investments,' whereas previously they were dismissed as barroom wagers—and this was precisely the moment at which the overvalued market made buying stocks more wager than investment.

For two decades after the Crash, stocks were regarded as gambling by a majority of the population, and this impression wasn't fully revised until the late 1960s when stocks once again were embraced as investments, but in an overvalued market that made most stocks very risky. Historically, stocks are embraced as investments or dismissed as gambles in routine and circular fashion, and usually at the wrong times. Stocks are most likely to be accepted as prudent at the moment they’re not." (emphasis his)

Arguing that events like the October 1987 crash don't affect long-term returns, Lynch writes: "Whether it’s a 508-point day or a 108-point day, in the end, superior companies will succeed and mediocre companies will fail, and investors in each will be rewarded accordingly."

But he also claims that "wonderful companies become risky investments when people overpay for them... In 1972 [McDonald's] stock was bid up to a precarious 50 times earnings. With no way to 'live up to these expectations,' the price fell from $75 to $25."

In other words, stocks always go up in the long run, expect for the mediocre ones that don't, so you should stick to investing in wonderful companies that do go up, except when they're overvalued, but whether or not the market is overvalued doesn't matter.

Fortunately, some of Lynch's other advice is more straightforward. He argues that investors should avoid complexity and invest in companies they can understand, be wary of Wall Street's conflicts of interest, and be skeptical of analyst recommendations. He also points out that being able to invest in smaller, lesser-known stocks is a big advantage for individual investors.

Many people consider Beating the Street a poor relation of One Up on Wall Street, but I liked it somewhat better. (I generally enjoy this kind of "time capsule" book.) It's interesting to read about Lynch's logic for buying or not buying certain stocks. One company that he considered recommending at the Barron's roundtable, EQK Green Acres, had increased its dividend every quarter during the prior three years. In a quarterly earnings report, the company suggests that it might forgo additional dividend increases. Lynch interpreted that as a sign of deeper problems at EQK and decided not to recommend the stock.

Beating the Street also describes Lynch's foray into European investments. In 1984, the American stock market had rallied 50% from its lows but European stocks were still very cheap. Lynch traveled to Sweden and met with the management of Volvo, which was trading at $34 despite having $34/share in cash and several profitable subsidiaries.

Each book contains a list of stocks that significantly outperformed the market during the 1970s and '80s. Their subsequent performance doesn't seem to have followed any pattern. Some stocks continued to do well, some became mediocrities, and some crashed and burned. In both books Lynch highlights Hanes, the manufacturer of L'eggs, as a great business, but pantyhose went out of style a couple years after Beating the Street was published:
"From 1995 a steady decline [in pantyhose sales] began, levelling off in 2006 with American sales less than half of what they had once been. This decline has been attributed to bare legs in fashion, changes in workplace dress code, and the increased popularity of trousers."

Such is the risk of buying wonderful businesses-- most of them cease being wonderful at some point. To be fair, Lynch acknowledges that "The trick is figuring out when [fast growers will] stop growing, and how much to pay for the growth," but he doesn't give much advice on how to do this.

2 comments:

  1. The problem with Peter Lynch, or for that matter, most legendary investors is, they tend to never fully communicate their philosophy(will elaborate). For example, Lynch says "buy stocks!", but in One Up, he has a chapter called passing the mirror test, where he says that most people(young people starting out, old people, etc.) should not invest, and even if people invest, it should only be that amount of money, without which they can do in the long run. This advice of Lynch is not widely known or quoted, as it is obvious that he asks people to save first before investing, and asks them to minimise risk. Also, he recommends 6 month check ups, and investing small amounts on a regular schedule etc., which is probably some of the most practical advice the average Joe can get.
    So, your criticism about sticking with wonderful companies for a very long time(till they suck) is already answered by Lynch. He has spoken in some detail about when to figure out that fast growers stop growing(his chart reading of the earnings graph and stock price graph). Of course, in the end, it is we who must critically examine and apply all this advice, and not get blindsided by the halo surrounding such people. I found that he was actually much more practical and relevant for a common, ordinary guy like me, and I have done decently in almost 2 decades of investing(one stock i picked, in India, called Sundaram Finance was a 10 bagger, but yes, there were dozens of losers as well)

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  2. Awesome review I like how you tell it how it is. Thinking of reading these books and doing a review for my blog, projectwealthy.com do you feel these books are too far out of date?

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