Peter Lynch: How to Invest Better Than Wall Street (Rare Interview)

People don't understand their natural advantages, and they don't use them. So that's bad, number one. But worse, number two, is if you don't think you're a good ice skater or if you're convinced you're not a good cellist, you're not going to try it. But people are buying stocks anyway. They're not discouraged; they just think it's a gamble.

We begin with Peter Lynch. Time magazine has called him America's number one money manager. During the 13 years he headed the Fidelity Magellan Fund, it was a top-ranked general equity mutual fund. His new book, "Beating the Street," offers advice on picking stocks and maximizing profits, and he's here to talk to us about a lot of things, including his own dramatic decision. Four or five years ago, Peter, welcome to the broadcast. Four or five years ago, you just said, and I've been managing all this money, I'm gonna do... I'm gonna quit.

"Yep, that's right."

And what? And you went to do what?

"Well, actually, I want to spend more time with my wife and my children."

Right, and it was an interesting situation because I loved my job; I adored my job, and I liked outside activities. When I was young, I wasn't involved in charity work until I was 30. No activities with younger children—you just read them a book and "Goodnight Moon," and they fall asleep, and it's all over. When they get older, this is more time involved. So I enjoyed the family. I was leaving for work at six in the morning, and I was getting home at seven o'clock at night, six days a week. This was in Boston, yeah. Traveling 14 days a month, it was just too much.

So I said, "You know, I said that's it, I can't take it." Fortunately, I had made enough money to say I could give up the job; I didn't have to give up the family or the outside activities.

And so what happened then?

"So I cut back from about an 80, a 90-hour a week to a 40 or 50-hour week. In the morning, I make breakfasts and lunches for the kids, and I do the spelling words and the Spanish words. Carolyn does the math and the science, and I see Carolyn in the morning, and off I go to a place. You have to go to... In my opinion, you have to go somewhere to do something. If you stay at home, you want to be answering the telephone or watching cartoons. Oh yeah, it's like falling asleep taking a nap. So she does the hard work."

Can I go?

"Fidelity gave me an office, I have a secretary, and I spend the majority of the time working on charity things like inner-city schools, inner-city libraries, inner-city housing. You know, helping people manage their money or... No, not at all. Just some of the charities. I'm on the investment committee of some of the Museum of Fine Arts. You know, I'm involved in Mass General Hospital, Boston College, United Way. But all the extra things I added to were real hands-on, actually being involved in charitable activities."

You wrote a book called "One Up on Wall Street," and I think that's one of the best-selling books ever about Wall Street, if I'm not correct. You can correct me. And so why then did you write another?

"Okay, okay, first of all, I was very lucky. I wrote it with John Rothschild; he made a big difference. But I think the reason I wrote it is the first... I try to explain to people their great advantages, their edges they have and that they should get involved in stocks, and they should do it on the right basis, on the first book."

Right? Yeah. And obviously, I didn't make a great impression because the percent of people's assets involved in stocks has gone down. In 1960, people had 40 percent of their financial assets, including their house, in stocks and mutual funds. That was down to 25. It's now down to 17.

And why do you think that is?

"Well, I think people... In the decade of the 80s was the best decade this century for stocks. I think people managed to lose money in the 80s doing it themselves because their methods were so flawed. So I really feel as though I wanted people to understand I don't want anybody to buy a stock. I'm saying if you're going to buy a stock, you should do certain things right. If you're not willing to do these things, you should leave your money in the bank."

Your philosophy is simple, and I'm remembering this from the previous book. I think we're now talking about the previous book, correct? Your philosophy was if you find something that you identify with...

"I remember that was the story of your wife and her hose. Your wife said these are the greatest things I've ever seen, right? And when your wife said that, you knew that this was a product that was better."

Right. You used to stay at La Quinta Motel, right? The service was better, whatever was better. The price was good too, and you said this is a place that I can determine... I, Peter Lynch, can tell that this is a good product, right? If these people make a good product, then their earnings are going to go up, therefore the stock's going to go up, right? And that's the kind of decision-making process you ought to go through, right? Do I have it?

"You've got it exactly right."

Well, I do. I don't think 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 happening, the price of oil, who's the president, who's being nominated for the Supreme Court, it's 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 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. And therefore, you gotta pay attention to these other things because they impact on earnings.

"They are very important, but you have no idea of knowing what they're going to do. Alan Greenspan is the head of the Federal Reserve, right? He cannot predict interest rates. Yes, he'd be the first to influence somebody, but he cannot predict what long-term insurance rates are going to be one year from now, two years from now, 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, 1982, with a 20 prime rate, 14 unemployment, 12 inflation. I don't remember anybody telling me in 1980 or '81 that 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. Here's a quote from you: "I own Dunkin' Donuts. When you own Dunkin' Donuts, you don't have to worry about Korean imports. You don't have to worry about M2 or M3." These are money supply figures, and what's happening to the money supply. This is the way you make money. If you don't understand what the company does, you should not be in it.

If you could predict the stock market, you could predict the economy, you could predict interest rates. If you go buy the wrong stocks, you're going to lose half your money anyway. Right? I'm saying people have natural advantages.

"Let's say what you do for a living is you're involved in the restaurant industry. Right? You supply paper products; you supply kitchen equipment; you help build restaurants. Right? You saw McDonald's, you saw Chi-Chi's, you saw Chili's, you saw Cracker Barrel, you saw Dunkin' Donuts, Kentucky Fried Chicken, Taco Bell. These are all... these stories... these were 40-fold. You made 40 or 50 times your money. You don't need to make that kind of money many times in your life, right? No, that's all you had to do was follow the restaurant industry."

People are in industries; they're in the publishing industry, they're in the chemical industry, the paper. Why don't they just stay within their industry? You only need a few stocks a decade. How many good stocks do you need a lifetime? Instead of people—they're in the restaurant industry, they're buying biotechnology stocks. The people in the campus, the people in the chemical industry are buying oil stocks. It's absolutely absurd.

People don't understand their natural advantages, and they don't use them. So that's bad, number one. But worse, number two is they don't... if you don't think you're a good ice skater, or if you're convinced you're not a good cellist, you're not going to try it. But people are buying stocks anyway. They're not discouraged; they just think it's a gamble.

"So therefore they go forward, and they bet on one stock for a week and a half, and it goes up, and they make two dollars on it, then they sell it and they buy something else. When three years are over, all they've done is generate a lot of commissions. They've probably lost money. That's a mistake."

So your advice is what?

"If you don't understand a company, if you can't explain it to a 10-year-old in two minutes or less, yes, don't own it. Because when it goes down—let's say the stock goes down too—you won't understand what's going on. What do you do? Do you buy more? Do you flip? Chances are your broker doesn't either. He or she certainly doesn't know about it. I mean, who knows what advances, what all these things are, what auto backplanes and megaflops are? Who knows what all these..."

So buy what you know. Buy in your industry. Buy what you know. Buy local businesses.

"So suppose you... you don't have an industry. I mean, you know... you don't really... you... what you buy? Company local companies, right? Companies in your own industry."

Ten years after Walmart went public, ten years after Walmart went public, it's a 25-year-old company now, right? You could have bought the stock and made 50 times your money on it—50 times! This is if you bought it 10 years after it was public already; it had already gone up five-fold.

So you could have made 250-fold, but I'm saying let's say you were in a town, they came into it, they said, "Boy, these prices are great! They're doing terrific! I like the bargains!" And you checked it out; you spent a little bit of work on it.

Yeah, I mean, people are very careful. When they buy a dishwasher, they do some research. They'll put ten thousand dollars in some stock they hear on a bus. So if you did a little bit of research, you say, "Walmart's only 10 percent of the country. They're not even saturated there! Why can't they go to the rest of the country?"

"So is this... this is more of the same?"

"It's more of the same, plus I show examples. It's a touch more detail. This actually shows me in action. I picked 21 stocks early in 1992. Some work, some don't. I follow those companies. Some of the companies, the fundamentals deteriorate; some, they improve. I watch those companies go through the year. I also explain the retail industry. I try to make it very simple. I talk about... a wonderful example is a seventh-grade class. The teacher of that read my book and my first book that you were talking about—you and I did a show on that in Washington, do you remember that show? This is a long time ago."

She read the book, and I said, "If you made it through fifth-grade math, you can do it in the stock market." She says, "Okay," she started teaching it in seventh grade, seventy-seven-grade class. These kids had to study companies; they had to look at their balance sheets to see if they were solvent, and they picked stocks. These stocks were up 69 over two years when the market was up only 20. They picked stocks like Limited, they picked The Gap, they picked Walter. They understood these companies. They also picked IBM. I lost money on that too. Yeah, I mean, everybody makes mistakes, but it did... yeah. But I'm saying this was... this was the school, Saint Agnes School in Arlington, Mass. But in addition, in the decade of the '80s, there were 8,000 investment clubs. These are amateurs, sort of, right? Average people just investing in these investment clubs. 62 percent of them, of these clubs, beat the market, and in the decade of the '80s, only 25 percent of professionals beat the market."

Let me go back to one other subject. You're coming back to Fidelity, aren't you?

"Just... I'm not going to do something. When I finish this book, I've been working about one or two days a week the last year and a half on this book. Right now, I'm done with the book, I'm going to go back to maybe one day a week working with the younger analysts, just listening to them, talking to them. I'm not telling them to buy zero, zero lifestyle... not totally. I'm not going to run another fund. 13 years is plenty of running a fund. I'm just going to work with younger analysts, let them ask questions, I'll ask them questions. It's going to be a lot of fun."

Now, do you still follow—that is, do you manage any money for anybody other than yourself?

"No, no, I manage money with other people for some charities, right? But no, I don't manage anybody's accounts. You're not doing some mutual funds, pension funds, no, it's nothing. I'm obviously cold turkey."

All right, cold turkey.

"Cold turkey."

Are you happy you did this?

"I mean, I was delighted. It's good."

And you like your new life?

"Oh, it's fabulous."

Let's talk about the Clinton economic plan. What do you think of it?

"Well, I think his theories are excellent. You know, clearly these theories are excellent. Well, he claims that we're going to do more investing and less spending, right? And that statement you can't argue with; less consumption, more savings. You absolutely have to invest more in education; you have to invest more in companies; you have to invest less than just spending money. I mean, today, people are encouraged to spend. You spend money, let's say you put an addition on your house, you spend money on that, that you can get a tax deduction because the interest on it's tax-deductible. If you invest, if you take your money and put it in the bank, you're taxed at a very high rate. They have this incredibly unfair term; it's called unearned income. When you... every time I do all the income taxes, and I fill out the number for what you made, the money you put in the bank is unearned income. What a... it's an insulting term."

Anyway, if you buy a stock and you make money on it, you pay a 28 tax on it. Yeah, guess what the capital gains rate is in Japan?

"The capital gains rate in Japan is 10-zero-zero, right? I mean, we're not encouraging people to save; we're not encouraging people to invest, so you're encouraging people to speak in favor of the elimination of the capital gains tax that Bush... reducing it or eliminating it, and I'm glad that Clinton didn't raise it. I mean he raised other taxes. This fairness thing I understand."

And what about this tax-the-rich business? You buy that?

"I think fairness... it's a debate, what's fair. I think... I certainly think raising taxes is appropriate if it's the same time you cut the spending. It's a lot easier to raise taxes than cut spending. If we can cut spending and get government's share of the gross national product reduced, it'll be fair. But our country works very well. It's working extremely well. I mean, you just want it to get spun out of control."

You don't buy into the stimulus package?

"Don't buy into that at all."

You believe that we don't need to go out and create jobs?

"Charlie, we've had eight recessions since World War II. We've got out of every one of them. This is number nine; there's nothing unique about the system. We'll get out of this one. In the decade of the '80s, 1980s, we had 18 million jobs in the United States."

Yeah, but as soon as you say that, as you know, people are saying, "Yeah, Peter, but look what we did when Ronald Reagan came to the White House. The deficit was what, 70 billion, 65, 70 billion dollars? And now it's approaching 350 billion dollars?"

Right, and the amount of money that we have to spend to pay off the interest on that debt is saddling us and destroying us.

"I agree, you're right. I agree with you."

Don't tell me how many jobs we could now...

"But you can always create jobs if you're willing to..."

No, no, the government didn't create that! The 500 largest companies in the '80s eliminated 3 million jobs.

"Eliminated 3 million, and we added 18 million. These 2.2 million businesses started, 2.2 million businesses started in the '80s. Now, some of them didn't make it, right? But if, on average, they have 10 employees today, that's 22 million jobs. What the only thing that creates wealth, the only thing that creates taxes to pay for all these wonderful things is jobs. There is something magic about jobs, and jobs come from companies starting. That's what I should say. Small companies creating jobs create all the jobs."

Right, so that's what I'm talking about. This is not voodoo economics; this is the real thing. You have to encourage people to take some risk, put their money out, and go start a business.

"It's a risky proposition, and you do that by what kind of government policies other than a zero capital gains or a 10 capital gains?"

Lower interest... What is the capital gains tax now?

"28... 28! Plus, it's the highest capital gains rate we've ever had in the history of this country!"

Right? It's never been this high. I mean, it's terrible how high the capital gains rate is; that's not encouraging people to invest. What you want, you want to have lower sales, you want to have lower interest rates, lower paperwork. People start a business now; they have this much paperwork to fill out. That's regulation. They go crazy; that's crazy. You gotta cut that out."

Yeah, well, okay, but that means something. I mean, a lot of people say without those kinds of regulations, then people would be creating dumps into the rivers and not protecting you.

"But these are regulations, it's not protecting the health of their employees. I mean, look what happened down in my home state of North Carolina because of, you know, the fire they had down there. I mean, people say if you don't have some kind of government regulation and companies aren't doing their job to protect their workers, then this is not the kind of society."

Some of these regulations relate to the size of your paper clips.

"Exactly! Some of this paperwork is mind-blowing; sometimes you can do it with one piece of paper. One!"

That's right! I mean, okay, that would be a good policy. I think Clinton really wants to make it work.

"Yeah, the capitalist system works. Obviously, you want to protect the consumer, and business people carry it to extremes. When the oil monopoly and the steel monopoly... that's wrong too. I mean, I think trusts should be broken up. There is a role for government."

IBM, what happened to them?

"IBM had a wonderful business; they used to go to companies like Fidelity, Chase Manhattan. They used to come and explain to these people how to use computers. Yeah, they didn't know how to use computers. They went to companies with very talented, experienced people, IBM's IBM, and explained to people how to use computers. Today, all these companies like Johnson & Johnson's American Bristol-Myers, they have people in the company already that know computers backward and forward. The same IBM people walk in with these solutions. They don't need all those people."

So all these companies took IBM's business away from...

"No, no, they do it internally; they have experts internally now that are trained in... it's called management information systems. They have all these fancy acronyms; they have skilled people. All they want now is software and a cheap box; they don't need all these."

So what should IBM do? What should this board of directors of IBM, which is looking for a new chief executive officer, be looking for?

"Well, a lot of people are saying they ought to just market Myerson, the number two guy to Ross Perot down there, and said maybe they ought to dismember the thing or maybe they ought to create all kinds of little entrepreneurial companies from within."

Break it up?

"They'll eventually... they have incredible technology, they're very skilled, they have a lot of determination. Right now, unfortunately, it's sad, they have too many employees, they have too many factories, they try to do it all themselves. They're working the right direction. There's nothing wrong with the direction they're going; they will turn it around. They're in a hard process because the technology is advancing all the time."

What was the genius of Bill Gates and Microsoft, which now has a higher net worth than IBM, doesn't it?

"Well, there's a lot of bright people. He said, 'Oh my God!' His net worth alone might be more than IBM's profits individually. Yeah, his brilliance is a lot of brilliant people and a lot of luck. IBM adopted MS-DOS as the operating system, right? They rushed the market with the first computer. They needed an operating system, and he had the only one! If they'd waited a couple of years, they could use their own. So MS-DOS became the basic operating system of every computer, whether it was a compact computer. The only computer system that didn't use it was Apple; Apple had their own operating system. So every computer that went out there all over the world needed MS-DOS."

He uses that to come along with Windows.

"So he was there; he was like the gasoline when... whatever car... if you had the rights to all the gasoline, you don't care whose cars are... said another way. I mean, IBM was making all of these razors, and he was making all the razor blades."

You got it right! Yeah, absolutely! And there were other people making razors to use his blades.

"Exactly, so he had all the razor blades around. Now, obviously, he's a bright person and rich."

Yeah, and EDS, EDS, you know, Ross Perot. What do you think of Perot?

"I think he's a well-meaning, talented guy; he's done a lot of good things in education."

For president?

"I did."

You did? Yeah, Perot was your guy?

"Yep, I sure did."

Why?

"Well, it was sort of a protest vote, exactly, because I know, in our state, you know, I mean, in our state; that's just, yeah. I know in Massachusetts, the Democrat was going anyway, and I really thought his concepts of cutting down on the deficit and more investment... oh, cutting down deficits is a good idea."

Oh, it's absolutely a good idea!

"It's a terrific idea. Give me five good stocks to watch, not to buy, but just to watch. Five ideas that you think where people are really on the right track and created a good business."

"Well, I think not touting stocks. America? I just want to know what Peter likes, okay?"

"Well, we have a company in Boston called OBA Pan. It's a company that makes croissants, and they make breads, and they have a state-of-the-art bagel they're working on. I can understand that company."

"Me too! They're only in about 20 percent of the country. They're starting to roll right now. It's... I think, you know, the price is fully priced. And I think now is the time... selling for what's fully priced."

"Oh, I mean, it's 25 times next year's earnings. I mean, that's very high, right? But I think over a long period of time, I'm hoping the market goes down, and the stock will go down, and I'm going to back up the truck and buy a lot of shares. I think now is the time to look at cyclical stocks. I think the economy is going to get better around the world in '94. It's already getting better in '93, and it's even better in '94."

Better in '94 because right now it's slumping in Germany and it's slumping in Japan.

"So I think now is the time to look at cyclical companies in the paper industry, the aluminum industry, the steel, and see they've cut the cost. They're the lowest-cost producers in the world, and when things get better, they're going to make a lot of money."

What are these little small companies we should look at?

"Oh, there's tens of thousands of small companies."

Well, I guess I'd say OBA Pan's the smaller part. Another one would be Jay Baker; it's a relatively small... they do... it's a retailer, or Supercuts. They do haircuts. That's a small company.

Peter Lynch is back with a new book called "Beating the Street." It is always interesting to have him here. "One Up on Wall Street" was one of the better bestsellers ever about Wall Street, and it is very simple, which most things are very simple. When you understand them, you can understand what makes the world work. I appreciate you being here.