Peter Lynch on The Recession and Picking Stocks

Peter Lynch delivered a compound annual return of 29.2% over 13 years at the Fidelity Magellan Fund. In a recent interview, Lynch shared some of his insights on the economy and offered timely and excellent advice for all investors.

Former Fidelity Magellan fund manager Peter Lynch is one of the greatest mutual fund managers of the last 100 years. Under his management, the Magellan Fund returned 29.2% per annum, almost double the value of the index which returned 15.8% compounded annually from 1977 to 1990. Lynch was on charge of the Magellan Fund during that time.
 
Lynch is also well known for his three books, most notable “One Up on Wall Street”, “Beating the Street”, and “Learn to Earn”. During his tenure at the Fidelity Magellan Fund, he managed to beat the S&P 500 in 11 out of 13 years. He is currently a research consultant at Fidelity Investments at the ripe age of 66.
 
In a recent article published in Globes Online, an Israeli news site, Lynch put forth his views on equity market investments and the general outlook for the market given the unprecedented crisis we saw in 2008.
 
"The past decade is one decade out of a hundred years in which we have known the markets," Lynch says. "We started it at an extraordinary peak in the stock market as a result of the sharp rises in 1999, but in a sense the past decade was the lost decade on the stock market mainly because stocks were overvalued."
 
Lynch says regardless of the past decade and in particular the financial and liquidity crisis of 2008, the former Fund Manager says nothing has changed in terms of what we know about stocks. "We had 11 recessions since World War 2, and this is the twelfth that we have experienced in the US and the biggest, without a doubt. But you have to remember that only 2-3 years ago, the market was at an all-time high. Now the question is how we will emerge from this recession, and whether we will return to the growth patterns at the rate we saw before it”, he says.
 
Lynch has also not lost faith in equities despite the collapse of several top tier institutions in 2008. "Company profits in the US have grown at 6-7% a year, basically since World War 2. If we add to that the dividend yield, which is 2% a year, that is approximately the average annual return on stocks," he explains. “Companies like IBM (IBM), Procter & Gamble (PG), Coca Cola (KO), Pepsico (PEP), Walgreen (WAG), or Exxon Mobile (XOM)… will make more money in ten years time than they make today, so that their share prices will rise to reflect that growth. Over the past 30 years, the profits of McDonald's (MCD) have tripled and the stock market has risen threefold, and that's true of other stocks.”
 
Many of his insights and comments will be familiar to those who have read his books. In particular, Lynch argues, "Stock market companies have succeeded in growing their profitability, and that's the reason to buy shares. When you buy shares in a company, if it manages to produce profits, you are a partner in those profits. On the other hand, if you buy an IBM bond, after 20 years, the company will repay you the money and say 'thank you very much.' It will pay you the interest, but it will not be loyal to you, and you certainly will not enjoy the fruits of its success. That's the big difference between bonds and stocks."
 
One of the most famous of Lynch’s concepts was that of “diworsification". You can't understand and be familiar with all of the market all of the time. You have to exploit your advantage to invest in what you really understand in depth, and not in what you don’t. If you gamble and buy oil stocks one year and retail stocks the next and electronics stocks the year after that, that's not investment. That's just a bet.” Wise words from a true legend.” Lynch basically says that the average investor needs just 5 to 10 companies in their portfolio. Similarly, his investment approach of buying 3 or 4 good companies over ten years certainly served him well.
 
Lynch also puts forward some advice for investors operating today. “The most important organ in the body as far as the stock market is concerned is the guts, not the head. Anyone can acquire the know-how for analyzing stocks. We've had many recessions on average once every eighteen months we have had a 10% fall on the stock market over the past 50 years, and once every five years we have had a fall of 20-30%, which is called a bear market. Usually, this goes along with bad news, with your neighbor who lost his job, and with the value of your house that falls. The news is bad, and so you get out of the market, and when you read in the newspaper that the situation has improved, you go back in. You buy when you see that things are fine, and sell when you see that they are bad. But that's not the way. You have to decide what position in shares you will be comfortable with, and to understand that even in a bear market, time is on your side. What the market will do for a period of a year ahead is random. If you need the money for your child for college or for a wedding in a year's time, it's important that you should know that the market will be random over that year. But if you're looking at an investment range of 10 or 20 years, company profits will be on your side, and stock prices will be higher. Recessions happen, and right at the point that things seem gloomiest, people withdraw their money from the market, and just then the market start to climb. Look at the latest rally that we have had since March. The economy still isn't sufficiently stable. We have an unemployment rate higher than 10%, and the recovery in many areas of the economy is fragile, but we had an impressive rally nevertheless. The stock market looks to the future and not to the past. The tendency of people to run when the situation is bad and go in only when it's good is a good formula for losing money. The stock exchange is a good place to be. In fact, it was the best place to be in the last 100 years, even if it wasn't like that in the past decade."
 
As for the next 11 years, Lynch is equally upbeat: “I think it will be a good place to be in the 10, 20, and even 100 years to come."

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