One Up on Wall Street: How to Use What You Already Know to Make Money In

by Peter Lynch

  If you owned the Nifty Fifty and held on to the lot for twenty-five years (preferably you were stranded on a desert island with no radios, TV sets, or magazines that told you to abandon stocks forever), you’re not unhappy with the results. Though it took them a generation to do it, the Nifty Fifty made a full recovery and then some. By the mid-1990s the Nifty Fifty portfolio had caught up and passed the Dow and the S&P 500 in total return since 1974. Even if you bought them at sky-high prices in 1972, your choice was vindicated.

  Once again, we’ve got the fifty largest companies selling for prices that skeptics describe as “too much to pay.” Whether this latter-day Nifty Fifty will suffer a markdown on the order of the 1973–74 fire sale is anybody’s guess. History tells us that corrections (declines of 10 percent or more) occur every couple of years, and bear markets (declines of 20 percent or more) occur every six years. Severe bear markets (declines of 30 percent or more) have materialized five times since the 1929–32 doozie. It’s foolish to bet we’ve seen the last of the bears, which is why it’s important not to buy stocks or stock mutual funds with money you’ll need to spend in the next twelve months to pay college bills, wedding bills, or whatever. You don’t want to be forced to sell in a losing market to raise cash. When you’re a long-term investor, time is on your side.

  The long bull market continues to hit occasional potholes. When One Up was written, stocks had just recovered from the 1987 crash. The worst fall in fifty years coincided with a Lynch golfing vacation in Ireland. It took nine or ten more trips (we bought a house in Ireland) to convince me that my setting foot on Irish sod wouldn’t trigger another panic. I didn’t feel too comfortable visiting Israel, Indonesia, or India, either. Setting foot in countries that begin with “I” made me nervous. But I made two trips to Israel and two to India and one to Indonesia, and nothing happened.

  So far, 1987 hasn’t been repeated, but the bears arrived in 1990, the year I left my job as manager of the Fidelity Magellan Fund. While the 1987 decline scared a lot of people (a 35 percent drop in two days can do that), to me the 1990 episode was scarier. Why? In 1987 the economy was perking along, and our banks were solvent, so the fundamentals were positive. In 1990 the country was falling into recession, our biggest banks were on the ropes, and we were preparing for war with Iraq. But soon enough the war was won and recession overcome, the banks recovered, and stocks took off on their biggest climb in modern history. More recently we’ve seen 10 percent declines in the major averages in the spring of 1996, the summers of 1997 and 1998, and the fall of 1999. August of 1998 brought the S&P 500 down 14.5 percent, the second worst month since World War II. Nine months later stocks were off and running again, with the S&P 500 up more than 50 percent!

  What’s my point in recounting all this? It would be wonderful if we could avoid the setbacks with timely exits, but nobody has figured out how to predict them. Moreover, if you exit stocks and avoid a decline, how can you be certain you’ll get back into stocks for the next rally? Here’s a telling scenario: If you put $100,000 in stocks on July 1, 1994, and stayed fully invested for five years, your $100,000 grew into $341,722. But if you were out of stocks for just thirty days over that stretch—the thirty days when stocks had their biggest gains—your $100,000 turned into a disappointing $153,792. By staying in the market, you more than doubled your reward.

  As a very successful investor once said: “The bearish argument always sounds more intelligent.” You can find good reasons to scuttle your equities in every morning paper and on every broadcast of the nightly news. When One Up became a best-seller, so did Ravi Batra’s The Great Depression of 1990. The obituary for this bull market has been written countless times going back to its start in 1982. Among the likely causes: Japan’s sick economy, our trade deficit with China and the world, the bond market collapse of 1994, the emerging market collapse of 1997, global warming, ozone depletion, deflation, the Gulf war, consumer debt, and the latest, Y2K. The day after New Year’s, we discovered that Y2K was the most overrated scare since Godzilla’s last movie.

  “Stocks are overpriced,” has been the bears’ rallying cry for several years. To some, stocks looked too expensive in 1989, at Dow 2,600. To others, they looked extravagant in 1992, above Dow 3,000. A chorus of naysayers surfaced in 1995, above Dow 4,000. Someday we’ll see another severe bear market, but even a brutal 40 percent sell-off would leave prices far above the point at which various pundits called for investors to abandon their portfolios. 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.”

  It’s often said a bull market must scale a wall of worry, and the worries never cease. Lately we’ve worried our way through various catastrophic “unthinkables”: World War III, biological Armageddon, rogue nukes, the melting of the polar ice caps, a meteor crashing into the earth, and so on. Meanwhile we’ve witnessed several beneficial “unthinkables”: communism falls; federal and state governments in the United States run budget surpluses; America creates seventeen million new jobs in the 1990s, more than making up for the highly publicized “downsizing” of big companies. The downsizing caused disruption and heartache to the recipients of the pink slips, but it also freed up millions of workers to move into exciting and productive jobs in fast-growing small companies.

  This astounding job creation doesn’t get the attention it deserves. America has the lowest unemployment rate of the past half century, while Europe continues to suffer from widespread idleness. Big European companies also have downsized, but Europe lacks the small businesses to take up the slack. They have a higher savings rate than we do, their citizens are well educated, yet their unemployment rate is more than twice the U.S. rate. Here’s another astounding development: Fewer people were employed in Europe at the end of 1999 than were employed at the end of the prior decade.

  The basic story remains simple and never-ending. Stocks aren’t lottery tickets. There’s a company attached to every share. Companies do better or they do worse. If a company does worse than before, its stock will fall. If a company does better, its stock will rise. If you own good companies that continue to increase their earnings, you’ll do well. Corporate profits are up fifty-five-fold since World War II, and the stock market is up sixtyfold. Four wars, nine recessions, eight presidents, and one impeachment didn’t change that.

  In the following table, you’ll find the names of 20 companies that made the top 100 list of winners in the U.S. stock market in the 1990s. The number in the left-hand column shows where each of these companies ranked in total return on the investor’s dollar. Many high-tech enterprises (the likes of Helix, Photronics, Siliconix, Theragenics) that cracked the top 100 are omitted here, because I wanted to showcase the opportunities that the average person could have noticed, researched, and taken advantage of. Dell Computer was the biggest winner of all, and who hasn’t heard of Dell? Anybody could have noticed Dell’s strong sales and the growing popularity of its product. People who bought shares early were rewarded with an amazing 889-bagger: $10,000 invested in Dell from the outset generated an $8.9 million fortune. You didn’t have to understand computers to see the promise in Dell, Microsoft, or Intel (every new machine came with an “Intel Inside” sticker). You didn’t have to be a genetic engineer to realize that Amgen had transformed itself from a research lab into a pharmaceutical manufacturer with two best-selling drugs.

  Schwab? His success was hard to miss. Home Depot? It continued to grow at a rapid clip, making the top 100 list for the second decade in a row. Harley Davidson? All those lawyers, doctors, and dentists becoming weekend Easy Riders was great news for Harley. Lowe’s? Home Depot all over again. Who would have predicted two monster stocks from the same mundane business? Paychex? Small businesses everywhere were curing a headache by letting Paychex handle their payroll. My wife, Carolyn, used Paychex in our family foundation work, and I missed the clue and missed the stock.

  Some of the best gains of the decade (a
s has been the case in prior decades) came from old-fashioned retailing. The Gap, Best Buy, Staples, Dollar General—these were all megabaggers and well-managed companies that millions of shoppers experienced firsthand. That two small banks appear on this list shows once again that big winners can come from any industry—even a stodgy slow-growth industry like banking. My advice for the next decade: Keep on the lookout for tomorrow’s big baggers. You’re likely to find one.

  —Peter Lynch with John Rothchild

  TWENTY BIG WINNERS IN U.S. STOCKS IN THE 1990s*

  * This list does not include companies that were acquired by other companies.

  Source: Ned Davis Research

  Prologue:

  A Note from Ireland

  You can’t bring up the stock market these days with-out analyzing the events of October 16–20, 1987. It was one of the most unusual weeks I’ve ever experienced. More than a year later, and looking back on it with some dispassion, I can begin to separate the sensational ballyhoo from the incidents of lasting importance. What’s worth remembering I remember as follows:

  • On October 16, a Friday, my wife—Carolyn—and I spent a delightful day driving through County Cork, Ireland. I rarely take vacations, so the fact that I was traveling at all was extraordinary in itself.

  • I didn’t even once stop to visit the headquarters of a publicly traded company. Generally I’ll detour 100 miles in any direction to get the latest word on sales, inventories, and earnings, but there didn’t seem to be an S&P report or a balance sheet anywhere within 250 miles of us here.

  • We went to Blarney Castle, where the legendary Blarney stone is lodged inconveniently in a parapet at the top of the building, several stories above the ground. You get to lie on your back, wiggle your way across the metal grating that comes between you and a fatal drop, and then while gripping a guardrail for emotional support, you kiss the legendary stone. Kissing the Blarney stone is as big a thrill as they say—especially the getting out alive.

  • We recovered from the Blarney stone by spending a quiet weekend playing golf—at Waterville on Saturday and at Dooks on Sunday—and driving along the beautiful Ring of Kerry.

  • On Monday, October 19, I faced the ultimate challenge, which demanded every bit of intelligence and stamina that I could muster—the eighteen holes at the Killeen course in Killarney, one of the most difficult courses in the world.

  • After packing the clubs into the car, I drove with Carolyn out on the Dingle peninsula to the seaside resort of that name, where we checked into the Sceilig Hotel. I must have been tired. I never left the hotel room for the entire afternoon.

  • That evening we dined with friends, Elizabeth and Peter Callery, at a famous seafood place called Doyle’s. The next day, the 20th, we flew home.

  THOSE PETTY UPSETS

  Of course, I’ve left out a few petty upsets. In hindsight they hardly seem worth mentioning. One year later you’re supposed to remember the Sistine Chapel, not that you got a blister from running through the Vatican. But in the spirit of full disclosure, I’ll tell you what was bothering me:

  • On Thursday, the day we left for Ireland after work, the Dow Jones industrial average dropped 48 points, and on Friday, the day we arrived, that same average dropped another 108.36 points. This made me wonder if we should be on vacation at all.

  • I was thinking about Dow Jones and not about Blarney, even at the moment I kissed Blarney’s stone. Throughout the weekend, between the rounds of golf, I sought out several phones and talked to my office about which stocks to sell, and which stocks to buy at bargain prices if the market fell further.

  • On Monday, the day I played Killeen at Killarney, the aforementioned average dropped yet another 508 points.

  Thanks to the time difference, I finished the round a few hours before the opening bell rang on Wall Street, or else I would probably have played worse. As it was, a sense of gloom and doom carried over from Friday, and perhaps that explained my (1) putting worse than I usually do, which in the best of times is terrible; and (2) failing to remember my score. The score that got my attention later that day was that the one million shareholders in Magellan Fund had just lost 18 percent of their assets, or $2 billion, in the Monday session.

  My fixation on this mishap caused me to ignore the scenery on the way to Dingle. It could have been Forty-second and Broadway, for all I knew.

  I wasn’t napping all afternoon at the Sceilig Hotel, as the earlier paragraph may have implied. Instead, I was on the phone with my home office, deciding which of the 1,500 stocks in my fund should be sold to raise cash for the unusual number of fund redemptions. There was enough cash for normal circumstances, but not enough for the circumstances of Monday the 19th. At one point I couldn’t decide if the world was coming to an end, if we were going into a depression, or if things weren’t nearly as bad as that and only Wall Street was going out of business.

  My associates and I sold what we had to sell. First we disposed of some British stocks in the London market. On Monday morning, stock prices in London were generally higher than prices in the U.S. market, thanks to a rare hurricane that had forced the London exchange to shut down on the preceding Friday, thus avoiding that day’s big decline. Then we sold in New York, mostly in the early part of the session, when the Dow was down only 150 points but well on its way to the nadir of 508.

  That night at Doyle’s, I couldn’t have told you what sort of seafood meal I ate. It’s impossible to distinguish cod from shrimp when your mutual fund has lost the equivalent of the GNP of a small, seagoing nation.

  We came home on the 20th because all of the above made me desperate to get back to the office. This was a possibility for which I’d been preparing since the day we arrived. Frankly, I’d let the upsets get to me.

  THE LESSONS OF OCTOBER

  I’ve always believed that investors should ignore the ups and downs of the market. Fortunately the vast majority of them paid little heed to the distractions cited above. If this is any example, less than three percent of the million account-holders in Fidelity Magellan switched out of the fund and into a money-market fund during the desperations of the week. When you sell in desperation, you always sell cheap.

  Even if October 19 made you nervous about the stock market, you didn’t have to sell that day—or even the next. You could gradually have reduced your portfolio of stocks and come out ahead of the panic-sellers, because, starting in December, the market rose steadily. By June of 1988 the market recovered some 400 points of the decline, or more than 23%.

  To all the dozens of lessons we’re supposed to have learned from October, I can add three: (1) don’t let nuisances ruin a good portfolio; (2) don’t let nuisances ruin a good vacation; and (3) never travel abroad when you’re light on cash.

  Probably I could go on for several chapters with further highlights, but I’d rather not waste your time. I prefer to write about something you might find more valuable: how to identify the superior companies. 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 as soon as I remember what I ate at Doyle’s, I’ll let you know.

  Introduction: The Advantages of Dumb Money

  This is where the author, a professional investor, promises the reader that for the next 300 pages he’ll share the secrets of his success. But rule number one, in my book, is: Stop listening to professionals! Twenty years in this business convinces me that any normal person using the customary three percent of the brain can pick stocks just as well, if not better, than the average Wall Street expert.

  I know you don’t expect the plastic surgeon to advise you to do your own facelift, nor the plumber to tell you to install your own hot-water tank, nor the hairdresser to recommend that you trim your own bangs, but this isn’t surgery or plumbing or hairdressing. This is investing, where the smart money isn’t so smart, and the dumb money isn’t really as dumb a
s it thinks. Dumb money is only dumb when it listens to the smart money.

  In fact, the amateur investor has numerous built-in advantages that, if exploited, should result in his or her outperforming the experts, and also the market in general. Moreover, when you pick your own stocks, you ought to outperform the experts. Otherwise, why bother?

  I’m not going to get carried away and advise you to sell all your mutual funds. If that started to happen on any large scale, I’d be out of a job. Besides, there’s nothing wrong with mutual funds, especially the ones that are profitable to the investor. Honesty and not immodesty compels me to report that millions of amateur investors have been well-rewarded for investing in Fidelity Magellan, which is why I was invited to write this book in the first place. The mutual fund is a wonderful invention for people who have neither the time nor the inclination to test their wits against the stock market, as well as for people with small amounts of money to invest who seek diversification.

  It’s when you’ve decided to invest on your own that you ought to try going it alone. That means ignoring the hot tips, the recommendations from brokerage houses, and the latest “can’t miss” suggestion from your favorite newsletter—in favor of your own research. It means ignoring the stocks that you hear Peter Lynch, or some similar authority, is buying.