The Ridgewood Group Value Investing Blog

Besides his fame as an exceptional investor who helped thousands through the fund, Peter is also well know for writing two very good books on investing (see the Recommended Reading area in the Food for Thought section of our website for the books) that became best sellers. Peter’s fund continued to perform well even as the fund became the largest equity fund in the country. Peter Lynch was only 46 when he retired (no doubt to the consternation of his many investors) at the top of his game. According to Peter, the fund continued to outperform the market for the next 7 years after he left! Also interesting to students of investing and value investors in particular is that Peter’s approach featured wide diversification and opportunistic flexibility to buy any company for the Magellan Fund without arbitrary size or value versus growth limitations (in today’s parlance the fund had a “core” approach).

What struck me about Peter, more than the content of his talk, was that he was humorous and exceptionally funny. Though I expect that he has delivered some version of his talk many times (indeed he had a handout with his main bullet points on it - summarized below), he also made some funny observations which were clearly off the cuff. For example, the host of the conference was an investment bank that was very proud of being the bank with the highest profits per employee and after Peter was introduced, he quipped that “It makes you wonder why they don’t hire more people.”

In any event, the meat of Peter’s comments were essentially straightforward and very common sense oriented. Peter shared his rules/observations on investing (8 of them) and proceeded to share some thoughts on each point.

Peter S. Lynch’s Fundamental’s of Investing (With a brief summary of his comments in the parenthesis following including some of our notes on similarities to Warren Buffett whom we also admire here at The Ridgewood Group)

1.) Know What You Own (Most people don’t really know the reasons why they own a stock - you should. Ed’s Note: Similar to Ben Graham and Warren Buffet’s Businesslike Investing in your Circle of Competence)

2.) It is Futile to Predict the Economy, Interest Rates and the Stock Market (So Don’t Waste Time Trying - “If You Spend 13 minutes per year trying to predict the economy, you have wasted 10 minutes” Focus on the “facts” now at hand rather than predictions about the future)

3.) You Have Plenty of Time (to identify and recognize exceptional companies. He cited WalMart which if you bought it AFTER it has gone up 10x in its first 10 years, you got another 60x return over the next 30 years. Bottom line: Don’t be in a rush - look at plenty of stocks, but be patient. Note: Buffett’s “Wait for the Perfect Pitch”)

4.) Avoid Long Shots (he is a great manager but his record was ZERO out of 25 investing in companies with no revenues but a “bright future” to sell. His advice if you run across a company that falls into this category but still excites you - do nothing and write down the name. Look at it again in 6 to 12 months and see if you still think it is good. If it is one of the good ones and went from 5 to 15 while you waited, per point #3 above, you probably still have plenty of time. Following this rule could keep you out of trouble. Note: Benjamin Graham and Warren Buffett talked about Avoiding Speculations and focusing on Investments instead)

5.) Good Management is Very Important and Buy Great Businesses (Good management is very important - probably the most important consideration. It may also be the most difficult item on this list to get right. His advice: look for good companies because a good management in a bad business will probably fail. “Buy a business any fool can manage because eventually one will” Buffett has also observed that when a good management meets a bad business, it is the business that prevails.)

6.) Be Flexible (Lots of unexpected things happen, some good and some bad. Many of his best investments happened for the “wrong” reasons, i.e. his original thesis was off, but the investment still worked out. Sometimes he was absolutely right about the growth but the investment was still lousy and he did not make any money. So be flexible and humble)

7.) Knowing When to Sell is Hard (Before you make a purchase, you should be able to explain why you are buying/own it in terms that an 11 year old could understand - three sentences at most. Remember this reason and sell the holding when the reason no longer continues to hold. Investing well does not take a genius - only need 5th grade math - so math has nothing to do with being a great investor)

8.) There is Always Something to Worry About (Which keeps things interesting. The 1950s were one of the best decades to own stocks, but from a geopolitical basis everyone was scared of nuclear war. In the early 1990s, everyone was scared about the Japanese taking over the world and beating America. Not coincidentally, more all-time worst market days occur on Mondays because people have the whole weekend to WORRY. His advice is to forget about all the global bad stuff because the key to good investing is not the brain, its having the Stomach).

In addition to the above points, Peter also shared his Ten Most Dangerous Things People Say About Stock Prices reproduced below. Even more than the points above, Peter’s good sense of humor came through when he discussed these old saws:

1.) “If it’s gone down this much already, how much lower can it go?” (answer: Zero)

2.) “If it’s gone this high already, how can it possibly go higher?” (some of the best companies grow for decades)

3.) “Eventually they always come back.” (no they don’t - there are lots of counterexamples)

4.) “It’s only $3 a share, what can I lose?” ($3 for every share you buy)

5.) “It’s always darkest before the dawn.” (Its also always darkest before it goes absolutely pitch black. Don’t buy a security just because price dropped and it is cheaper now)

6.) “When it rebounds to my cost, I’ll sell.” (The stock does not know you own it! Don’t take it so personally Note: this comment is explained by the well documented psychological tendencies called loss aversion and anchoring bias which are talked about in Behavioral Finance. If you liked it at ten, you should love it at 6 - so either buy more or sell)

7.) “What me worry? Conservative stocks don’t fluctuate much.” (There is no such thing as a conservative stock - the average stock fluctuates between 50% to 70% from its high to its low price every year. There is a graveyard where all the “conservative” stocks get buried. Companies and businesses change!)

8.) “Look at all the money I lost - I didn’t buy it!” (Don’t beat yourself up about the missed opportunities because it is not productive - when he managed the Magellan Fund, he almost never owned one of the 10 best performing stocks in a given year, but he did fine anyway).

9.) “I missed that one. I’ll catch the next one.” (Doesn’t work that way)

10.) “The stock has gone up - so I must be right” or “The stock has done down - so I must be wrong.” (Technical analysis is not worth much. So many people like a stock at 20 but hate it at 12 - never made much sense to him).

Peter’s fundamentals, like those of many other super investors are grounded in common sense and an understanding of human misjudgments and failings. At the Ridgewood Group, we draw inspiration from outstanding investors like Peter who remind us that in investing our greatest challenges are often internal. Hope you enjoyed his comments as much as we did.

Of course, the vast majority of people probably know him only superficially as “that very rich guy, second to Bill Gates” or “that Coke-and-Gillette-buy-and-hold-forever guy.” In a culture which deifies success for its own sake and idolizes the super rich (good looking or not) and the famous and beautiful, its not surprising that Buffett has a large and diverse following. Almost anyone who has ever met, read about, or studied him in any depth has come away humbled and impressed at a far deeper level.

Until recently, the only person I have encountered who disliked Buffett was my ex-boss in investment banking, who openly expressed disdain for the Oracle of Omaha. I discounted this hatred, however, since his criticism seemed to be based more on personal bitterness related to Warren’s handling of bonus compensation when this individual was working as a senior banker at Salomon Brothers during Buffett’s brief Chairmanship than on any direct criticism of the man’s principles.

I was therefore surprised and amused when I recently ran across Victor Niederhoffer’s blog called Daily Speculations. I don’t know him. He seems to be a interesting, colorful, even eccentric individual who calls himself “The Chairman”. The name of his blog says much about his mindset. But far more amusing are his postings on Buffett and Berkshire. I have not read more than a small handful of his posts, but it was not hard find gems like:

1.) Shorting Berkshire where he volunteers “Out of shame, hubris and spite, I shorted some extra Berkshire even though it is even more self-destructive and wrong to short a conglomerate like Berkshire than to try for a boast in squash. I doubtless will be licking my wounds on this, as my plan is to wait until it goes below $85,500, take my 10% or so profit, and then hedge it with some S&P futures.” or

2.) Nebraska Chronicles where he surmises that he has “read all the books about the Sage, [and] his bearish annual reports And I find that there are only two sensible and valuable things he has said (as he never talks in public about the importance of using tax losses and float from an insurance operation to buy stocks for the long term during a rising yield curve environment, and the importance of having very good friends and token ownership in the media, which are the actual sources of his success)” or

3.) Another post where he concludes that “Berkshire Hathaway has been hobbling along near its lows in the 81,000 handle as is appropriate for a company whose chief honcho infuses with disguised hubris his mantras: “I am so much more honest than you or her,” and “I cant find any good stocks to buy for the last 10 years” and, ” I find dishonesty rife in the investment field as compared to myself and the companies I buy, which I can buy in a flash by just looking at their financials, and I just look for companies I understand like See’s Candies and Brown Shoes.” However, the Friday 9/17 close of 2720, a 21-month low, seems to me the manifestations of the “Morse effect” (see EdSpec) so common in markets and life where a former revered statesman finds that all his former hagiographers are the most vehement in their execration when he stumbles. I found the same effect directed at me when I “went under” in 1997 (have I mentioned it in the last week?), as is appropriate.”

BTW, the last sentence is a reference to the following (quoted from an article by Robert Hunter called “Victor Niederhoffer’s Garage Sale” on derivativestrategy.com) which explains that “Niederhoffer’s $130 million funds blew up on October 27, 1997, when the Asian crisis spooked the U.S. equity market, wiping out all his capital. . . . In order to pay down his debts, Niederhoffer took a mortgage on his estate and sold an interest in a small investment banking business for $1 million, but these steps were not enough to maintain even a modicum of the lifestyle to which he and his family had been accustomed. The result: the silver had to go”

No doubt, Mr. Niederhoffer learned from his 1997 experience and should get kudos for being open about his own setbacks (we all have them). However, his comments above reminds me of the quote in the Food for Thought section of our website at http://www.ridgewoodgrp.com/ from Andrew Carnegie about never having meet someone who made a fortune from speculation and kept it.

My point in sharing the above is not to criticise Mr. Neiderhoffer, as he is certainly within his rights to have his opinion and share it with the world (thought he might want to carefully re-read and review Buffett’s many discussions on Margin of Safety given his 1997 experiences).

In a marketplace of ideas, we should all expose ourselves to multiple points of view with the hope that the best ideas will win out in the end. Indeed, as Charlie Munger has pointed out, Berkshire (and its annual meeting) is not far removed in many respects from the annual gathering of a cult (albeit one focused on celebrating and learning a number of fundamentally sound ideas). I know more than a handful of Buffett followers who think nothing of thoughtlessly substituting the Sage’s thinking for their own (even thought Buffett and Munger frequently and forcefully advise everyone to think for themselves).

I have no quibble with Mr. Neiderhoffer, though I think he is largely wrong in the above points (his point about float however is right - not that Buffett hides the fact). No, my point is to remind us that you simply can’t please all of the people all of the time (so you shouldn’t try). Also, since investing is a probabilistic pursuit, there is even a small chance that Neiderhoffer may, in time, be proven right in some of his contentions. My money, however, is on Buffett and I don’t think its going to be even close.