Peter Lynch: How to Invest in 2023 (RARE New Interview)

Mal Rushmore is one of the most popular historical landmarks in the United States. Carved into the side of a mountain are the faces of four influential presidents that changed the course of America forever: George Washington, Thomas Jefferson, Theodore Roosevelt, and Abe Lincoln. Given the countless number of influential Americans, it was probably a difficult decision to decide which four individuals got the honor of being chosen to be included.

Well, if I had to choose four faces for an investing Mount Rushmore, the choice would be pretty straightforward. There would be Warren Buffett, of course, universally regarded as the greatest investor of all time. Then there would be Ben Graham, the father of value investing. Jack Bogle would be on there; he founded Vanguard and brought low-cost index funds to the masses. Believe it or not, the fourth spot would be given to none other than Peter Lynch.

Lynch has quite the impressive track record. Over a 13-year stretch, he produced a nearly 30% annual compounded return for his investors in the legendary Quality Magellan fund. But even more importantly, he helped bring proper investing education to the public through his legendary speeches and books. But unfortunately for us, most of this material is decades old, and Peter rarely gives interviews anymore, which is why it was such a big deal that Peter gave a rare interview recently.

He shared his thoughts on the economy, the banking collapse, and how you should be investing now in the year 2023. Here's what he had to say. He, of course, is the vice chairman of Fidelity Management and Research and Advisory Board member of Fidelity Funds. From 1977 to 1990, he managed the Magellan fund, growing it from—You ready for this?—$20 million to $14 billion in 1990 at the time of his retirement.

"Buy what you know" is what Peter taught us, and it's so nice to see you this morning, Peter. "Good to be here! So, let's talk about buy what you know. I'm so curious these days how you're thinking about the economy."

"Well, I think people, they're investing in individual stocks—it’s sad. They're careful when they buy a refrigerator or an airplane flight or they're careful with their money, and they'll hear about a stock on the bus and they'll put five or ten thousand dollars on it. They have no idea what they do. So, you really got to be careful. Look at the company, look at the balance sheet. What is the reason the stock should be higher? The sucker's going up is not a good reason."

"Is your sense though that the style of investing that you pioneered is still doable and winnable today?"

"Well, I think looking for something different, literally something that's a good story. I mean, who would've guessed TJX, a local company, would have gone up 50-fold? Or Stop and Shop would go up tenfold? Or Analog Devices or Nvidia? I couldn't pronounce Nvidia, so you have to find a company that's either a turnaround or a company that's going to grow, like Panera or, you know, Family Dollar stores."

"I'm not saying that buys now, but that's what's made our—you know, Sears has rolled over, so you know, Kmart's rolled over, IBM slowed down. But we've had new companies come along, and that's the nature. You have to be looking for new companies and look at the balance sheet. If you can add five and five and get reasonably close to ten, you should be able to look at a balance—you say, 'Here's two depressed companies. They've gone from 50 to three; one comes, get three remain in cash and no debt; one's got three remain in debt, no cash. Which one are you gonna buy?' I mean, that’s not too hard to do."

According to Lynch, there are six types of stocks. He has a rule that you must know which category a stock falls into before you even think about buying it. The first is slow growers. These tend to be large companies that are usually in the maturity stage of their life cycle.

These companies tend to grow in line or maybe slightly more than that of the country's economy. These slow growers likely started out as fast growers, but over time growth slowed down due to the industry's growth stalling or the company simply running out of space to grow further. These slow grower companies tend to pay out large and consistent dividends due to the fact that there aren't many high-return investment opportunities for them. Companies that fall into this category in 2023 are 3M, Coca-Cola, and IBM.

The next category is Star wars. These are a group of companies that are growing at a medium pace. Think of this category as a middle group between the slow grower category and fast growers. Many stocks that fall into this category were once fast growers that have seen their growth rates slow due to their increased size, and this is a natural occurrence.

Just think about the math behind it: if a $100 million revenue company is growing at 40 percent, that is $40 million of revenue growth in a year. But if that company is bigger and is instead doing $10 billion in revenue, that same 40% growth rate means the company would have to grow sales by $4 billion. At a certain point, a company's increasing size makes growing at the same rate more difficult. Stocks that fall into this category in 2023 would be Apple, Amazon, and Tesla.

The next category of stocks is fast growers. This is Peter Lynch’s favorite category, and this category of stocks are companies that are growing rapidly. If you're looking for what Peter Lynch calls a "10-bagger," a stock that increases by a factor of 10, they will likely fall into this category. Believe it or not, Peter Lynch brought home more than 110-bagger stocks during his time as a portfolio manager at Fidelity.

Lynch identified that these 10-baggers tend to share the four same traits: they are one, small; two, growing fast; three, have dull names, dull products in dead industries; and four, don't get a ton of attention from Wall Street. The hunt for these elusive 10-baggers prompted Lynch to spend much of his time in this category of stocks. Stocks that I would classify today as fast growers would be the high-growth software stocks—names such as Spotify, Salesforce, and Snowflake.

The fourth category of stocks is cyclicals. These are companies whose sales and profits rise and fall regularly, mostly in line with the economy. When the economy is doing well, these companies are incredibly profitable; however, when things inevitably shift and the economy slows, these companies struggle the most.

Cyclical industries include automobiles, commodities, and transportation companies. The timing of buying cyclicals is extremely important. You have to know where in that industry cycle you are. Examples of cyclical companies in 2023 are General Motors, FedEx, and Union Pacific.

The next category of stocks is turnarounds. Unlike the first three categories, turnarounds have nothing to do with growth rates. Turnarounds are stocks that are beaten down because the company or industry is struggling or facing some type of existential threat. This can be a difficult category of stocks to invest in because it can be hard for you, as an outside observer, to see whether or not the company is successfully navigating its corporate transformation.

Companies that fall into this list in 2023 would be General Electric, Netflix, and Meta. The sixth and final category are what Peter Lynch refers to as asset plays. These are companies that have something valuable in their balance sheet that the market hasn't noticed yet.

This can be a company's cash position, real estate holdings, or some type of intangible asset. Asset plays tend to become more common during extreme periods in the stock market. Investors become so fearful that the selling pressure causes the stock to fall to unreasonable levels. In this category of stocks is where Warren Buffett first made a name for himself. He was buying stocks for less than the amount of cash that the company had on its balance sheet.

Examples of these stocks are rare to come by in 2023, but feel free to leave a comment below if you have an example. So, now that we understand the six types of stocks, it's important to understand that each category of stocks are impacted differently by the economy. One thing people are worried about now is the fallout from the collapse of Silicon Valley Bank and the repercussions that could have.

Here's what Peter Lynch had to say about that. "You know, we hear your terrible financial crisis in 1991. I think almost every major bank in Texas went under, Bank of New England, one of the oldest banks in the country, went under. It's like, you know, in 08-09, the banks were doing these no-doc loans and second mortgages and home improvement loans that people were buying boats with. Now that bank's being much more careful. So, we've gone through other crises; some banks will go under. You know, 400 went under after 08-09. Now we have stress tests. I think the banking system has improved. There'll be some companies going there; that's the nature of it."

"You know, it's nothing like. Imagine 1980-81 with double-digit inflation, teleportation, unemployment, and people were, the Japanese are going to take over the world. I mean, we were hopeless. I mean, you know, there's always something to worry about. I'd really—I've been my over 50 years of doing this; I think I'd be worried if there was, you know, somebody didn't bring up something to worry about. That's the nature of the business."

As Lynch mentioned, you need to know the health of a company's balance sheet to see if they can weather whatever economic conditions are ahead of us. So, let's take a look at Apple as an example. This is Apple's balance sheet at the end of 2022. We can see here that Apple has $99.6 billion in long-term debt. They also have another $9.7 billion in short-term debt. Combined, that is over $100 billion in debt.

That is a ton of debt! Apple is going to be in trouble if the economy slows, right? Well, not necessarily. It depends on a few other important things. We can also see here that Apple has $20.5 billion in cash and cash equivalents on its balance sheet. However, they also have $30.8 billion in short-term marketable securities and $114 billion in long-term marketable securities.

Marketable securities are just a fancy way of saying things like stocks and bonds. These can easily be converted to cash if the company were to hit a rough patch. So, we can add the $20.5 billion, the $30.8 billion, and the $114 billion to get a rough estimation of how much cash Apple has.

Adding these three numbers together, we can see that Apple has approximately $165 billion of cash the company could access if they absolutely needed to. How much debt a company has is irrelevant if you also don't consider its cash position. This is why the metric net debt was created.

Net debt is a way to think about how much debt a company has after factoring in its cash. The equation is simple: you take a company's debt and you subtract out how much cash it has. The number you are left with is the company's so-called net debt. If a company has $10 billion of debt and $3 billion in cash, that means their net debt is $7 billion.

So, let's do this calculation for Apple. Apple has roughly $110 billion in debt. The company also has approximately $165 billion in cash and cash equivalents that they could access if needed. Doing a net debt calculation gets us negative $55 billion for our net debt number. This negative number means Apple's cash balance exceeds the amount of debt the company has.

So, even though Apple has over $100 billion in debt, the company's balance sheet is still incredibly strong due to its large cash position. To Peter Lynch's point, this is why it's so important to understand a company's balance sheet. The math is incredibly simple; it's just a matter of understanding what to look for.

Speaking of which, if you found that explanation helpful, you will probably like the value investing course I'm currently in the works of putting together. I want to hear what you want to see in the course. It would mean the world to me if you could fill out a brief two-minute survey using the link in the description and pinned comment. As a thank you, I will send you a free PDF that can serve as a value investing cheat sheet you can use to help you analyze companies on your own.

While nobody knows for certain what's going to happen in the economy, people sure are worried about it. And that's for obvious reasons. When the economy is in a recession, it's harder for companies to make money, and the odds of them going out of business increases. Here's what Peter Lynch had to say about whether or not the economy is going to enter a recession.

"Well, we've had 13 recessions since World War II, and we've had 13 recoveries. Maybe we're going to have one. If this is a recession, it's probably the most predicted one ever. You know, I never know when we're going to go. I'd love to know the future. I think I'd give—it would help; I'd be a better investor. I paid five extra dollars for next year's Wall Street Journal; it would really help. I cannot predict the future, but this one—this recession is so expected, so predicted. Maybe it's coming; I don't know."

Peter Lynch has a famous quote: "If you spend 13 minutes a year on economics, you've wasted 10 minutes." Lynch focuses on the underlying health of the business and whether he can buy the stock for less than what it's actually worth. This investing philosophy is shared by the likes of Warren Buffett, Charlie Munger, and Howard Marks.

The reason some investors value economic predictions while others don't has to do with their investing style. You see, there are two general types of investors. The first group are referred to as so-called bottom-up investors. These investors tend to ignore what's happening in the economy and instead focus on the fundamentals of a particular business and industry—things like the company's financials, supply and demand in the industry, and the kinds of goods and services offered by the company.

On the other end of the spectrum, we have top-down investors. This group of investors look at big picture economic factors to make investment decisions. The most popular example of a top-down investor would be Ray Dalio. There are examples of very successful investors in both groups, but the key is to find which style aligns best with your own trades.

So, there you have it. Make sure to subscribe to the channel if you aren't already, because it's my goal to make you a better investor by studying the world's greatest investors. Talk to you again soon.