Peter Lynch: How to Invest in 2023

Peter Lynch: The man, the myth, the legend. He ran the Magellan fund at Fidelity between 1977 and 1990, where he achieved a 29.2 percent annual return. The guy is an investing master. He also wrote the book "One Up On Wall Street," which you know at this point is basically required reading for all value investors. On top of that, it's also one of the best-selling stock market books of all time.

Now, Lynch doesn't really do many interviews, but I was watching through a lot of his old commentary recently, looking for insights that specifically apply to the market conditions that we see today, heading into 2023. I was really surprised at how much stuff I actually found that was useful for right now.

As we know, our main issue heading into 2023 is high inflation and rising interest rates, which is causing asset prices like stocks and real estate to suffer. It looks like they're going to be the big issues throughout 2023 as well. So, with that in mind, let's firstly hear Peter Lynch's opinion about investing during times where inflation is up and interest rates are rising.

What he says might just surprise you in how perfectly relevant it is for today's environment. People understand there's a hundred percent correlation with what happens to a company's earnings over several years and what happens to the stock. If the company, McDonald's, has done very well as a company, right, the stock has done very well.

People worry about too much money supply, what's happened to the price of oil, whether who's the president, who's being nominated for the Supreme Court, the ozone layer. It has nothing to do—McDonald's earnings go up, the next 10 years, the stock will go up. But what they will say to you, Peter, is that, as you know, and why am I telling you this? But anyway, it's fun to tell you this.

They're telling you that these other things influence the amount of earnings of a particular company. If we're in a recession, people are not going to spend as much money on going to the movies or whatever they do, right? Therefore, you got to pay attention to these other things because they impact on our earnings. They are very important, but you have no idea of knowing what they're going to do.

Alan Greenspan's the head of the Federal Reserve, right? He cannot predict interest rates. Yes, he'd be the first to admit he can influence them, but he can't predict them. He cannot predict what long-term interest rates are going to be one year from now, two years from now, or three years. He's even surprised how low they are now, so how am I supposed to predict interest rates? How am I supposed to predict the economy?

You certainly remember the recession of '82. Yes, in 1982, we had a 20 prime rate, 14 unemployment, and 12 inflation. I don't remember anybody telling me in 1980 or '81 that it was going to happen. All of a sudden, we had the worst recession since the Depression. I didn't read about it in the paper.

So it’s crazy to think about these things. You know, his overarching point is that yes, the macro is important; yes, it influences prices. But as an investor, it's one of those things that is short-term and you can't control it. So if you can't predict it and you can't control it, then why should you spend your time thinking about it?

This is a trap that many investors have made this year, and it's honestly fair because it's all that the media has been talking about. You know, the FED has had another meeting, and they've raised rates. The Bureau of Labor Statistics released this month's CPI data, blah, blah. But you can't get caught up in that sort of stuff as an investor.

You need to be laser-focused on each potential investment you're looking to make and judge each opportunity on its own. Stocks are not lottery tickets; there's a company behind every stock. If a company does well, the stock does well. It's not that complicated.

People get too carried away, and first of all, they try and predict the stock market. That is a total waste of time; no one can predict the stock market. They try to predict interest rates. If anyone got interest rates right three times in a row, they'd be a billionaire. It’s certain there are not that many billionaires on the planet. There can’t be that many people who can pick interest rates, because there'd be lots of billionaires, and no one can predict the economy.

I had a lot of people in this room were around in 1981 and '82, when we had a 20 prime rate with double-digit inflation and double-digit unemployment. I don't remember anybody telling me in 1981 about it. I didn't read or study all this stuff. I remember anytime we had the worst recession since the Depression.

What I'm trying to tell you, it would be very useful to know what the stock market is going to do. It'd be terrific to know that the Dow Jones average year from now would be X, that we're gonna have a full-scale recession, or where interest rates going to be 12%. That's useful stuff. You never know it, though; you just don't get to learn it.

So I've always said if you spend 14 minutes a year in economics, you've wasted 12 minutes. And I really believe that. It's a classic line by Peter Lynch, but it really hammers home the idea that while macroeconomics kind of makes the world go around, it's really not what we as long-term value investors should be focused on.

For example, 2007 was the last time interest rates were higher than they are now. But imagine not buying a business like Amazon, Apple, or Google just because you were scared of interest rates. It's obviously a bad call in hindsight. But even today, with the market down, there'll still be tons of investors bailing on their portfolios based on a fear that interest rates could go a lot higher and stocks may suffer.

As Peter Lynch says, what we really need to be doing is focusing on the earnings of each individual company. You know, how profitable are they? Are they getting more profitable? How much cash could they return to shareholders each year? Is that growing? These are the questions to ask.

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All right, back to Peter Lynch. So we shouldn't be focusing on the macro; fair enough. But what should we do now that the market is down 15%? Is it a time to wait and see, or is it a time to buy at a discount?

Well, we had a huge run. I mean, the market was 4,000 just, you know, two and a half years ago, and it rounded up to 8,300 in August. You know, like any big rally, sometimes it backs off, and it's healthy, in fact. I mean, I'd rather it gone down a thousand points than gone to twelve thousand.

If you look at Japan, Japan went from five thousand to fifteen thousand on their Dow. It was fairly priced at fifteen thousand on earnings and everything else. Then it went to forty thousand, and that caused seven years of inflated real estate, people overspending, and basically they've been in a recession for five or six years. Because their market went up too high, the market was too high; you're discounting earnings seven, eight, or ten years out.

Isn't that the story of the past few years? Interest rates were at zero, and the market just absolutely ripped. But now we're seeing the opposite: interest rates are up, and the stock market is down. But Lynch's key point here is that you shouldn't be concerned about this. He even says, you know, it's healthy.

Because when the market is hot and you do your discounted cash flow analyses, usually the conclusion you come to is that the stock has to execute perfectly over the next five years to actually justify its current valuation. But on the other hand, when the market drops, things start to swing in the long-term value investors' favor.

And that's really what you need to remember. When the market goes down, we need to stay focused on the long-term. I may have been right six times out of ten, but if I'm right, I make a double or triple. Occasionally, it offsets the times you lose 30 or 40 percent. In fact, you could be right a third of the time as long as you have a lot of good results.

So when you're short, you can only make 90. When you're long, you make tenfold or five-fold. So I think long is the way to be. Corporate profits have grown about seven or eight percent a year; that means they double, but including dividends, about every 10 years. Could quadruple every 20, go up eightfold every 40. That's the kind of numbers you're interested in.

Then, a 10-year bond today is a little over two percent. So I think the stock market's the best place to be for the next 10, 20, 30 years. The next two years, no. I've never known what the next two years are going to bring, and that's a very good point. You know, in the next two years, nobody knows. Nobody. I really wish I could get that point across to more people.

You know, in the next two years, the stock market could go up, or it could go down, and there's no way to know which way it's headed. But over 10, 20, 30 years, the likely outcome becomes much clearer. Businesses get more productive, they earn more, or they increase their valuations, and stock prices go up.

We can take a coin out and flip it; I have no idea what the next thousand points is going to do. The next 6,000 points is going to be up; the next 14,000 points can be up. The next 20,000 points can be up, but you don't know where the next thousand is going to be up. Nobody does, and it's futile to try and guess it.

Corporate profits will be a lot higher 10 years from now; it'll be a lot higher 20 years from now. That's what you could rely on. Microsoft didn't exist 20 years ago; Staples didn't exist 20 years, and Federal Express didn't exist 20 years ago. New companies will come along.

20 years ago, that's what makes Amgen; it has two one billion-dollar drugs that didn't exist 20 years ago. New companies that come along, that's what makes this country work. So, that's the game—stay focused on the long term and watch for those companies that pop up on your radar that look really solid.

The ones that you understand, the ones that have a competitive advantage, the ones that have really well-oiled management teams, and then lastly, and most importantly, the ones that offer a steep discount to intrinsic value.

This has been the problem over the past few years. Unfortunately, there have been many wonderful businesses out there, but basically, all of them have been at really high prices. So much so that they really did need to execute perfectly over the next 10 years for their valuation to be justified.

This is Peter Lynch talking to exactly that scenario. You say to yourself, I think this company is going to earn something in the future. If it's already discounting that, if it's selling at a huge multiple, you see it's already—it has to work, and then it's only going to stay even.

So you have to see yourself, if I'm right, how much am I going to make? If I'm wrong, how much am I going to lose? That's the risk-reward ratio in stocks that we talk about. If I'm right, I hope I'm going to double or triple my money. If I'm wrong, maybe I'll lose 30 or 40. That's a favorable ratio.

If you say, if I'm right, the stock's not gonna go up; it's already discounting terrific things. If discounting terrific things are already in the stock, I don't know, okay? That's really going to be the secret to investing well in 2023. Watching these valuations, you know what we're looking for are companies that are wonderful but also valued low enough that the risk-reward is in our favor.

For example, if you calculate that a stock is going to grow at, you know, 15% per year for the next 10 years, and if that happens, you think right now the shares are worth 50 bucks. Well, if the stock sits at 50, then that's an annoying spot to be in if you buy the shares; the company has to execute perfectly to make you a return.

What we're looking for are the stocks that you've calculated to be worth fifty dollars today that are actually selling for 25. That's what Peter Lynch was saying. And for those wondering how you do that, well, I'll actually leave a link on the screen right now to an in-depth video on calculating intrinsic value. I would go over it here, but it's a very long topic, so please check out that video if you actually wanted to learn that process.

But long story short, we're finding wonderful companies that are valued well below intrinsic value, and that's when we seize the opportunity of this market weakness.

All these public companies out there, here's the company I really like. The fundamentals are terrific; their earnings are doing well; their competitors are doing poorly. I think this company's doing terrific, and all of a sudden, the stock might have gone from 40 to 30 because of this decline. That would say, wow, here's a chance to buy it.

So you're trying to see that some companies might have been overpriced at 60, and all they did was go to 50 and say, big deal. So you're trying to find companies you liked anyway right now; you liked them, and now they've had a haircut. That's what you would do—not just like the one from overpriced to fairly priced, sometimes fairly priced at the start of this exercise and then had a very, you know, five-for-four sale.

So that is it, guys. We're looking for companies on sale, ones that you know were fairly priced and have now dropped into margin of safety territory thanks to the movement of the broader market.

The one thing we don't do is get too deep in the weeds of macroeconomics and end up being spooked out of our tried-and-true long-term value investing strategies.

Anyway, guys, that will just about do us for today. Thanks very much for watching the video. Of course, leave a like on the video if you did enjoy it, and subscribe to the channel if you would like to see more. But guys, that will just about do us for today, and I'll see you guys in the next video.