Beating the Street

Peter Lynch

📚 GENRE: Business & Finance

📃 PAGES: 336

✅ COMPLETED: September 17, 2021

🧐 RATING: ⭐⭐⭐⭐⭐

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Short Summary

Legendary Fidelity Magellan Fund manager Peter Lynch explains some of the thoughts and strategies that brought him and his clients big success in the investing market. Lynch discusses why stocks have outperformed bonds historically, how to keep your cool when the market falls, and why your focus should always be on the company, not the stock price.

Key Takeaways

1️⃣ Stocks > Bonds — With the exception of the 1930s, the returns from stocks have historically dominated the returns from bonds. Stocks are the superior investment because they allow you to participate in the company’s success rather than simply serving as a creditor to the company, as is the case when you buy bonds. Because of their fixed nature, inflation can also really hurt bond returns, particularly over the long term.

2️⃣ Focus on Companies, Not Stocks — Your attention should be on the company’s financial health and growth, not the day-to-day movement of its stock price. Stock prices move sporadically for a ton of random reasons, many of which have nothing to do with the company. Stocks are not all that risky over the long haul if you do your research on the company itself and ensure that it is growing, making good decisions, and has healthy financial statements. 

3️⃣ Keep Your Head — When the market falls, that’s the time to buy more shares at good prices, not panic and sell. Again, make sure you are investing in good quality companies, but you should be happy about market dips.

Favorite Quote

"This is one of the keys to successful investing: Focus on the companies, not on the stocks."

Book Notes 📑

*Did not take chapter-by-chapter notes on this one. Running list below.

  • The worst thing you can do is invest in companies you know nothing about
    • People spend huge amounts of time researching the best toilet paper but won’t spend time researching a company before dropping $10k on it in the market
  • History shows that stocks are the best place to invest money (over bonds, money market fund, etc.) over a long period of time
    • Bonds and money market funds have their purposes for older folks needing safe current income (bonds) and those who are going to need the money soon for a house purchase, for example.
    • Stocks were only outperformed by bonds in one decade: The 1930s.
  • Market corrections and drops are normal and have happened routinely over history. Don’t panic. Buy more shares of good companies.
    • Market drops are a good thing for good investors 
  • Tip: The stock market really isn’t a gamble as long as you pick companies that you think will do well, and not just because of the stock price.
  • Tip: Over the long term, it’s better to buy stocks in small companies.
    • Small to mid-size companies have the potential for the most growth vs large blue chips. 
    • Young investors should especially invest in these because they have a longer time horizon and can afford some small declines. 
  • Dollar Cost Averaging is a good strategy
    • Regular, scheduled investing over time, regardless of how the market is performing 
    • P.33: Good example 
  • Before buying a stock, you want to:
    • See Revenue and Net Income increasing steadily
    • See the stock at a reasonable price
  • The NAIC has a lot of good resources to help you learn about researching companies 
  • The key to making money in stocks is to not get scared out of them 
  • Mondays have historically been the worst market days of the week
    • People sit and worry on the weekends and convince themselves to sell shares
  • December has historically been the worst market month of the year.
    • People sell their shares at a loss so they can capture their capital tax loss for the upcoming tax filing season in April.
    • People sell shares so they can buy holiday gifts 
  • Over the past 70 years, stocks have delivered 12% every year to investors
    • T-Bills, bonds, CDs = less than half of that 
  • Over the past 70 years, there have been 40 scary drops of over 10%
    • Of these 40, 14 were a drop of 33% or more, including the 1929-1933 sell off.
    • In 39 of the 40 declines, you would have been sorry for selling your stocks 
    • Lesson: The market has always come back, even from the Big Drop in 1929. Hold your stocks, ride it out, and buy during market declines.
  • Bonds absolutely suck
    • Inflation kills bonds and the purchasing power of bonds 
    • You can get income from dividend stocks that also appreciate in share price value.
    • When interest rates rise, bond prices go down
      • Interest rates and bond prices have an inverse relationship 
  • Index Funds/ETFs have proven to be way better than managed funds.
    • $100k in VOO in 1983 would have went to $308k by 1991!!
  • Always look at the P/E Ratio!
    • If you can find good companies trading at low P/Es, that can be a good buying opportunity.
  • Quote (P. 102): “This is one of the keys to successful investing: Focus on the companies, not on the stocks.”
    • Read the 10-K and 10-Q statements
    • Listen to management conference calls 
    • Read the Wall Street Journal
    • Study the financial statements 
  • Restaurant chains can be great long-term plays. By expanding across the country, these companies can keep up a 20% growth rate for 10-15 years.
    • As Philip Fisher said in his book, you are looking for companies that have growth potential.
    • Ex. Taco Bell 
  • The Rule of 72 is useful in determining how fast money will grow
    • Formula: Take annual return as a percentage and divide it into 72.
    • The result is the # of years it will take to double your money.
      • Ex. 72 / 15% annual return = 4.8 years. Your money will double in 4.8 years at that rate of growth. 
  • When interest rates are up, stocks suffer and bonds thrive. And Vice versa.
    • People seek the safety in bonds when interest rates are up because bonds guarantee the rate of interest while stock can be more risky and unpredictable 
  • Quote (P. 110): “Why investors attempt to prepare for total disaster by bailing out of their best investments is beyond me (Justin). If total disaster strikes, cash in the bank will be just as useless as a stock certificate.”
  • You should WANT the market to fall a bit. It creates chances to buy great companies at bargain prices.
    • The market has ALWAYS come back, even after the 1929 free fall. 
    • Declines are TEMPORARY. Celebrate them and BUY SHARES. 
  • Running a big mutual fund can be tough. Lynch writes about his experience running Fidelity Magellan.
    • As the fund continued to succeed and attract more money from investors, he had to find ways to invest the money in the market.
    • This meant he had research, visit, and buy new stocks constantly. 
    • He also had to increase his position in his favorite stocks as more money flowed into the fund. 
    • But when people sold their Magellan shares, he had to sell some of the stocks in the fund to raise enough cash to “redeem” the sellers. Magellan was an open-end investment company (aka mutual fund).
      • In this sense, the shareholders play a major role in a fund manager’s strategy. If everyone panics during a correction and sells their fund shares, the fund manager is forced to sell shares at the worst possible time to raise enough money to redeem the shareholders. 
    • His top holdings for awhile were automakers (led by Chrysler), foreign stocks, and long-term T Bonds (he had bought these when interest rates were in the double digits. As interest rates came down, his bond prices went up. Inverse relationship. 7!)
  • Quote (P. 130): “I can’t quantify the contribution that skeptics made to my performance, but I don’t doubt that it was substantial. They said a billion was too big, then 2 billion, 4, 6, 8, and 10 billion, and all along I was determined to prove them wrong.”
    • Lesson: Like all successful people I’ve studied, let the doubters fuel you. Have a chip on your shoulder. COMPETE! 
  • Looking at a company’s Earnings Per Share (EPS) is a good way to analyze a company’s net income/earnings trends over time.
    • You can also look at the past trends and try to predict or estimate the company’s EPS in future years. You obviously want the EPS to grow.
  • It’s OK to lose money on a stock. The key is to not hold onto it for too long. And definitely don’t buy more of it. 
  • Cyclical stocks are volatile. You don’t want to be in them for too long, but they can be extremely profitable if bought and sold at the right times.
    • Cyclical stocks are affected by macroeconomic changes, where its returns follow the cycles of an economy.
    • Companies that have cyclical stocks include car manufacturers, airlines, furniture retailers, clothing stores, hotels, and restaurants.
      • When the economy is doing well, people can afford to buy new cars, upgrade their homes, shop, and travel.
  • P. 142-147: Great tip here about analyzing a company’s stock chart, which shows a line for the price of the stock compared to its earnings line.
    • Per Peter Lynch, you do not want to invest in a company if its market price line is ABOVE its earnings line.
      • When this is occurring, the stock is way overpriced. At best in a good market, the price will “consolidate” and move laterally on the chart. At worst in a bad market, the price will fall substantially so it is below the earnings line again.  
    • You want to invest in companies where the market price line is under/well under the earnings line. This shows potential for the market price to rise considerably in a good market. 
    • Ex Image: 
  • Take advantage of the January Effect
    • This occurs in the fall, when people begin tax-selling their stocks before the end of the year. Usually, small stocks are hit really hard by this. You can find good small stocks and hold them through into January, which is when the prices for these stocks go back up. 
    • Small companies’ stocks have risen 6.86% in price in January alone, while stocks in general have risen 1.6%
  • INVEST IN THINGS THAT YOU LIKE AND KNOW
    • Ex. DraftKings, Apple, Microsoft
    • As a customer, you can often spot good companies just from enjoying their products or service. 
  • As a rule of thumb, a stock should sell (P/E Ratio) at or below its growth rate (the percentage it is growing its net income/earnings every year).
    • This is a sign that the stock is undervalued.
    • Not sure how relevant this is ok today’s market where everything has a high P/E ratio.
  • The best way to buy a company you like that is overpriced is to make a small investment in it and then increase your position when it begins to sell off. 
  • Tip: A technique that works repeatedly is to wait until things in a certain industry (like real estate) go from bad to worse and then buy shares in the top companies in that industry.
    • Again, you are looking to take advantage of bad news and negativity that causes share prices to go down.
  • When a company buys back its own shares, a couple things happen.
    • Current investors have their ownership stake go up because there are now less shares in the market. Opposite of dilution.
    • By purchasing its own shares, the company drives the price per share up. So the market price of the shares will increase because there is now less supply. Current investors can sell at a higher price. 
    • EPS goes up because there are less shares outstanding.
    • By eliminating shares in the open market, the company is preventing a hostile takeover.
    • If the buy back shares are dividend yielding shares, the company reduces its dividend payment to shareholders on the balance sheet, which is used with after-tax dollars.
      • By not having to pay as much in dividends, share buybacks can result in increased earnings/net income, which is always a good thing
  • It’s a good sign when insiders/executives of the company are not selling their shares and instead are buying shares of the company. 
  • Goodwill on the balance sheet: The amount paid in an acquisition that is above book value of the acquired company’s assets.
    • Ex. Coca Cola. If another company were to purchase Coke, it would have to pay way more than for just the assets of the company because the Coke brand name and reputation is so established. The excess amount over the book value of Coke’s assets would be marked as goodwill. 
    • When analyzing the balance sheet, you don’t want Goodwill to account for a large percentage of the company’s total assets or shareholders’ equity.
  • P. 170-175: Good info on analyzing the financial statements of a company.
    • You want shareholders equity to be around twice as high as total debt. The more equity and less debt, the better.
      • Ex. The company analyzed in the book had $148 million in shareholders equity and $167 million in total debt. Not good!
    • You want to see decreases in costs on the income statement in categories like SGA and COGS.
      • You always want to see companies cutting costs over the years. 
  • Try to find great companies in lousy industries. Good companies in bad industries dominate the market share and don’t have to deal with a ton of competition.
    • High performing industries attract competition.
  • Savings and Loans (S&L) institutions and banks make money by having loyal depositors who deposit their money at a certain interest rate. The bank then loans the money out to people at a higher interest rate and profits off the spread, after certain expenses and overhead are paid for.
    • Ex. Bankers borrow money at a 3% interest rate and lend money at a 6% interest rate.
  • Income Statement: Divide COGs by Net Revenue or Total Sales = Gross Profit Margin
    • This number tells you how much the company is making in gross profit on every $100 of sales 
    • Ex. 60% gross profit margin means the company is making $40 in profit on every $100 in sales.
  • Balance Sheet Analysis:
  • Auto companies and airlines are cyclicals, which rise and fall with the economy cycle. 
    • These are probably not great for long term buy and hold because they go up and down so much based on economic cycles and recessions.
  • Utility stocks are good for yield/dividend payments. 
  • Fannie Mae (FNMA) borrows money at cheap rates and buys mortgages from banks and savings/loans institutions that pay higher rates of interest on the mortgages. FNMA Profits off the spread.
    • They also package these mortgages and sell them to banks and on the stock market as “Mortgage Backed Securities.” They make profits this way too.
      • In the 70s, FNMA didn’t participate in this “packing” process. They just profited off the spread of borrowing vs the interest rates on their mortgages. Therefore, when interest rates in the market rose, FNMA was blasted because it then hurt their spread because they couldn’t borrow money as cheaply. 
      • The “reinvention” of its business model is what propelled it to a lot of success in the 80s and after. 
  • Restaurant companies can become great growth companies. These restaurant companies that are in their early stages have 15-20 years of fast growth ahead as they expand across the country. 
    • Key elements are growth rate, debt, and same-store sales. Debt should be low or nonexistent.
    • As long as Americans continue to eat 50% of meals outside the home, there will be good restaurant companies to invest in. 
  • A healthy portfolio requires a regular checkup every 6 months or so. You are looking to answer two questions:
    • Is the stock attractively priced relative to earnings?
    • What is happening in the company to make earnings go up?
  • Behind every stock is a company. Find out what it’s doing.
  • Often, there is no correlation between the success of a company’s operations and the success of its stock over a few months or even a few years. 
    • In the long term, there is 100% correlation between the success of the company and the success of its stock. This disparity is the key to making money. It pays to be patient, and to own successful companies.
  • Only have 8-12 stocks in your portfolio. Again, you have to be able to follow these companies and keep tabs on them through research. This takes time. Even 5 stocks are enough.
  • Never invest in a company without understanding its finances. The biggest losses in stocks come from the companies with poor balance sheets. Always look at the balance sheet!!
  • Concentration is actually better than diversification. 
    • Concentrate your money into 5-10 good companies that you can follow closely.
    • By diversifying too much, you lose the advantage of concentration. It only takes a handful of big winners to make a lifetime of investing worthwhile.
  • Nobody can predict interest rates, the future of the economy, or the stock market. Dismiss all such forecasts and focus on what’s actually happening to the companies you’re invested in.
  • When the market is hot and billions of dollars are pouring into mutual funds, buy shares in the companies that are selling the mutual fund products!
    • Schwab
    • Vanguard
    • Fidelity