Peter Lynch: How to Achieve a 30% Return Per Year

I'm amazed how many people own stocks. They would not be able to tell you why they own it. They couldn't say in a minute or less why they own it. If you really press them down, they'd say the reason I own this is, "The sucker's going up," and that's the only reason. That's the only reason they own it.

If you can't explain—I'm serious—you can't explain to a ten-year-old in two minutes or less why you own a stock, you shouldn't own it. And that's true. I think about 80 percent of people that own stocks.

Uh, thank you very much, it's a pleasure to be here. I love this town, and it's a thrill to be here with Jim Johnson. We did so much for Fannie Mae, and that was the greatest single stock in my life. It's still my largest position. If anybody wants to talk after about how to make money, I'll tell you how to buy more Fannie Mae. I've added Freddie Mac to the list too. Congressman Ed Markey went to Boston College, and also Boston College Law School, and has done a great job in Congress for everybody in this country, but especially the people in his districts in Massachusetts.

But great honors to have my wife, Carolyn, right here, my sweetheart, my great stock picker, who found Leggs and a bunch of other good stocks. So what I'm going to try and do today briefly is—I don’t know what I'm supposed to do with this gavel. I've never had one. I'm going to try and say some words on the things I've used over the years when I was an amateur when I ran Magellan. I still use them today. I think they make sense. I think they make a lot of sense for investors.

I frankly think it's a tragedy in America that the small investor has been convinced by the media—the print media, the radio, the television media—that they don't have a chance. They don't. The big institutions, with all their computers and all their degrees and all their money, have all the edges, and it just isn't true at all.

When they're convinced, when this happens, when this occurs, people act accordingly. When they believe it, they buy stocks for a week. They buy options, and they buy the Chile fund this week, and next week it's the Argentina fund. They get results proportional to that kind of investing, and that's very bothersome.

I think the public can do extremely well in the stock market on their own. I think the fact that institutions dominate the market today is a positive for small investors. These institutions push stocks on unusual lows; they push unusual highs for someone. They can sit back and have their own opinion, know something about an industry. This is a positive; it's not a negative.

So that's what I want to talk about. The single most important thing to me in the stock market for anyone is to know what you own. I'm amazed how many people own stocks. They would not be able to tell you why they own it. They couldn't say in a minute or less why they own it. Actually, if you really pressed them down, they'd say the reason I own this is, "The suckers going up," and that's the only reason. That's the only reason they own it.

If you can't explain—I'm serious—you can't explain to a ten-year-old in two minutes or less why you own a stock, you shouldn't own it. And that's true. I think about 80 percent of people that own stocks. This is the kind of stock people like to own. This is the kind of company people adore owning: it's a relatively simple company. They make a very narrow, easy-to-understand product. They make a one-megabit SRAM CMOS bipolar RISC floating-point data I/O array processor with an optimizing compiler, a 16 dual-port memory, a double-diffused metal oxide semiconductor monolithic logic chip for the plasma matrix vacuum fluorescent display.

It has a 16-bit dual memory, it has a UNIX operating system, four Whetstone megaflop poly-silicone emitter, a high bandwidth—that's very important—six gigahertz double metallization communication protocol, and asynchronous backward compatibility peripheral bus architecture, four-wave interleaved memory, a token ring interchange backplane, and it does, in 15 nanoseconds of capability.

Now, if you own a piece of crap like that, you will never make money! Never! Somebody will come along with more Whetstones or less Whetstones or a bigger megaflop or a smaller megaflop. You won't have the farthest idea what's happening, and people buy this junk all the time.

I made money in Dunkin' Donuts. I can understand it. When there were recessions, I didn't have to worry about what was happening. I could go there, and people were still there. I didn't have to worry about low-price Korean imports. I mean, I just didn't know. I can understand it, and you laugh; I made 10 or 15 times my money in Dunkin' Donuts. Those are the kinds of stocks I can understand. If you don't understand it, it doesn't work.

This is the single biggest principle, and it bothers me that people are very careful with their money. The public, when they buy a refrigerator, they read Consumer Reports. They buy a microwave oven—they do that. They ask people what's the best kind of radar range, what kind of car to buy. They do research on apartments when they go on a trip to Wyoming; they get the Mobile Travel Guide. Or California. When they go to Europe, they get the Michelin Travel Guide.

People will hear a tip on the bus on some stock, and they'll put half their life savings in it before sunset, and they wonder why they lose money in the stock market. When they lose money, they blame it on the institutions and program trading—that is garbage! They didn't do any research; they put a piece of junk. They didn't look at the balance sheet, and that's what you get for it.

That's what we're being driven to, and it's self-fulfilling. The public does terrible investing, and they say they don't have a chance. It's because that's the way they're acting. I'm trying to convince people there is a method; there are reasons for stocks that go up.

Uh, Coca-Cola—this is very magic. It's a very magic number: easy to remember. Coca-Cola is earning 30 times per share what they did 32 years ago. The stock has gone up 30-fold. Bethlehem Steel is earning less than they did 30 years ago; the stock is half its price of 30 years ago.

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 anybody predicted interest rates right three times in a row, they’d be a billionaire.

Concerned? There are not that many billionaires on the planet. You know, I took—I had logic, so I had a syllogism, and I studied these when I was at Boston College. 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.

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; I studied all this stuff. I remember every time we had the worst recession since the Depression.

So what I'm trying to tell you, it’d 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 going to have a full-scale recession, or interest rates are going to be 12. That's useful stuff. You never know it though; you just don't get to learn it.

I've always said if you spend 14 minutes a year in economics, you’ve wasted 12 minutes. I really believe that. Now, I have to be fair; I'm talking about economics in the broad scale—predicting the downturn for next year or the upturn, or M1 and M2 and M23b and all these M's. I'm talking about economics. To me, it's when you talk about scrap prices.

When I own auto stocks, I want to know what's happening with used car prices. When used car prices are going up, it's a very good indicator. When I own hotel stocks, I want hotel occupancies. When I own chemical stocks, I know what's happened to the price of ethylene. These are facts. If aluminum inventories go down five straight months, that's relevant; I can deal with that.

Home affordability, I want to know about when I own Fannie Mae or I own a housing stock. These are facts you can know; they're economic facts. Economic predictions are a total waste. And interest rates—Alan Greenspan is a very honest guy. He would tell you that he can't predict interest rates; he can tell you what short rates are going to do in the next six months.

Try and stick him on what the long-term rate will be three years from now, and he’ll say, “I don’t have any idea.” So how are you, the investor, supposed to predict interest rates if even the Federal Reserve can't do it?

But you should study history, and history is the important thing. You learn from it. What you learn from history is, the market goes down; it goes down a lot. The math is simple. There’ve been 93 years, a century; this is easy to do. The market's had 50 declines of 10 percent or more—50 declines in 93 years, about once every two years. The market falls 10 percent; we call that a correction. That means that's a euphemism for losing a lot of money rapidly; we call it a correction.

So 50 declines in 93 years—about once every two years—the market falls 10 percent. All those 50 declines, 15 have been 25 percent or more. That's known as a bear market. We've had 15 declines in 93 years. So every six years, the market's going to have a 25 percent decline. That's all you need to know; you need to know the market's going to go down sometime. If you're not ready for that, you shouldn't own stocks.

It's good when it happens. If you like a stock at 14—it goes to 6—that's great. You understand the company; you look at the balance sheet; they're doing fine. You're hoping to get to 22 with it. 14 to 22 is terrific; 6 to 22 is exceptional. So you take advantage of these declines; they're going to happen.

No one knows when they're going to happen. It would be very—people tell you about it after the fact that they predicted it, but they predicted it 53 times! You can take advantage of the volatility in the market if you understand what you own. I think that's the key element.

Another key element is that you have plenty of time. People are in an unbelievable rush to buy a stock. I'll give an example of a well-known company: Walmart went public in October of 1970. By 1970, it went public; it already had a great record; it had 15 years performance, a great balance sheet.

You could have waited ten years—saying you're a very conservative investor, you're not sure that Walmart can make it. You want to check. You see them operating in small towns; you're afraid they can only make it in seven or eight states. You want to wait until they go to more states. You keep waiting. You could have bought Walmart ten years after they went public and made 35 times your money.

If you bought it when they went public, you would have made 500 times your money. But you can wait ten years after Walmart went public and made, uh, over 30 times your money. You could wait three years after Microsoft went public and made 10 times your money. Now, if you knew something about software—I know nothing about software—if you knew someone in software, you would have said, "These guys have it. I don’t care who’s going to win—Compact, IBM. I don’t know who's going to win—Japanese computers. I know Microsoft MS-DOS is the right thing."

You could buy Microsoft again. I'm repeating myself: stocks are not a lottery ticket. There's a company behind every stock, and you can just watch it. You have plenty of time. People are in an amazing rush to purchase the security; they're out of breath when they call up. You don't need to do this.

The, uh, you need an edge to make money too. People have incredible edges, and they throw them away. I'll give you a quick example of SmithKline. This was a stock that had Tagamet. Now you didn't have to buy SmithKline when Tagamet was doing clinical trials. You don't have to buy SmithKline when Tagamet was talked about in the New England Journal of Medicine or the British version, Lancet.

You could have bought SmithKline when Tagamet first came out a year after it came out. Let's say your spouse, your mother, your father, you're a nurse, a druggist—you're writing all these prescriptions. Tagamet was doing an amazing job of curing ulcers, and it was a wonderful pill for the company because if you just stopped taking it, the ulcer came back! See, it would have been a crummy product if you took it for a buck and it went away, but it was a great product for the company.

But you could have bought it two years after the product was on the market and made five or six times your money. I mean, all the drugs, all the nurses, all the people—millions of people saw this product—and they're all buying oil companies, you know, or drilling rigs, you know, it happens.

Then three years later, four years later, a black company—a huge company, British company—brought Zantac, which was a better, at that time, an improved product. You could have seen that take market share, do well. You could buy Blacks and triple your money.

So you only need a few stocks in your lifetime; they're in your industry. I think of people: if you've worked in the auto industry—let’s say you're an auto dealer—the last 10 years, you would've seen Chrysler come up with a minivan. You've seen, if you're a Buick dealer, a Toyota dealer, a Honda dealer, you would have seen the Chrysler dealership packed with people. You could have made 10 times your money on Chrysler a year after the minivan came out.

Ford introduced the Taurus/Sable—the most successful line of cars in the last 20 years. Ford went up sevenfold on the Taurus/Sable. So if you’re a car dealer, you only need to buy a few stocks every decade. When your lifetime's over, you don't need a lot of five-baggers to make a lot of money starting with $10,000 or $5,000.

In your own industry, you're going to see a lot of stocks, and that's what bothers me. There are good stocks out there looking for you, and people just aren't listening, and they're just not watching it. They have incredible edges—people have big edges over me. They work in the aluminum industry; I see aluminum inventories coming down. Inventory is coming down six straight months; they see demand improving in America today. You know, it's hard to get an EPA permit for a bowling alley, never mind an aluminum smelter.

So you know when aluminum gets tight, you just can't build seven aluminum smelters. When you see this coming, you can say, “Wait a second, I can make some money.” When an industry goes from terrible to mediocre, the stock goes north. When it goes from mediocre to good, the stock goes north. When it goes from good to terrific, the stock goes north. There are lots of ways to make money in your own industry. You can be a supplier in the industry, you can be a customer.

This thing happens in the paper industry; it happens in the steel industry. It doesn't happen every week, but if you’re in some field, you'll see a turn, you'll see something in the publishing industry. These things come along, and it's just mind-blowing. People throw it away.

One thing I find—a couple of rules I want to throw out—I find useful. Excuse me, there are a lot of times people buy on the basis that the stock has gone down this much. How do you know how much further it can go down? I remember when Polaroid went from 130 to 100, people said, “Here's this great company, great record. If it ever gets below 100, you know, just buy every share.” You know, and it did get below 100, and a lot of people bought on that basis, saying, “Look, it's gone from 135 to 100; it's not 95! What a buy!” Within a year, it was 18.

This is coming with no debt. I mean, as a company, it was just so overpriced; it went down. I did the same thing in my—I think my first or second year at Fidelity. Kaiser Industries had gone from 26 a year to 16. I said, “How much more can it go? It's 16.” So I think we bought one of the biggest blocks ever on the New York—on the American Stock Exchange—of Kaiser Industries at 14. I said, “You know, it's gone from 26 to 16. How much lower can it go?”

Well, at 10, I called my mother and said, “Mom, you gotta, uh, look at this Kaiser Industries. I mean, how much lower can it go? It's gone from 26 to 10.” Well, it went to 6, it went to 5, it went to 4, and it went to 3. Now, I unfortunately—I would probably still be caddying or working at Stop & Shop, but it happened fast. It was able to—this was compressed.

At 3, I figured out there's something very wrong here because Kaiser Industries owns 40 percent of Kaiser Steel. They own 40 percent of Kaiser Aluminum. They own 32 percent of Kaiser Cement. They own Kaiser Broadcasting. They own Kaiser Santa Gravel. They own Kaiser Engineers; they own Jeep. They own business after business, and they had no debt!

Now, I learned this very early. This might be a breakthrough for so many people: it's very hard to go bankrupt if you don't have any debt. It's tricky. Some people approached that as a real achievement, but they had no debt, and the whole company at 3 was selling for about 75 million. At that point, it was equal to buying one Boeing 747! I said there's something wrong with this company selling for 75 million. I was a little premature at 16, but I said everything's fine, and eventually, this worked out.

What they did is they gave away all their shares to their shareholders—they passed out shares in Kaiser Cement, they passed out shares in Kaiser Aluminum, they passed out their public shares in Kaiser Steel. They sold all the other businesses, and you get about fifty dollars a share. But if you didn't understand the company, if you're just buying on the fact the stock had gone from 26 to 16 and then it got to 10, what would you do when it went to 9? What would you do when it went to 8? What would you do when it went to 7?

This is the problem that people have: they sell stocks because they didn't know why they bought it. Then it went down, and they don't know what to do now. Do you flip a coin? Do you walk around the block? You know, what do you do? Psychiatrists haven't worked so far; I've never seen them running in the side—the Psychological Psychiatry Fund. I've never seen this listed with the SEC to make it through as a mutual fund.

They haven't seemed to help; I've tried prayer; that hasn't worked. So if you don't understand the company, this is a problem. When they go down, eventually, they always come back. This one doesn’t work either. People think RCA just about got back to its 1929 high when General Electric took it over. A lot of double knits never came back. Remember those beauties? Floppy disks, Western Union—the list goes on and on.

People saying, “It'll come back!” Well, it doesn't have to come back. Here's another one you hear all the time: “It's three dollars; how much can I lose?” I've had people call me up, saying, “I'm thinking of buying a stock at three; how much can I lose?”

Well, again, you may need a piece of paper for this, but if you put $20,000 in a stock at fifty, or your neighbor put $20,000 at full at fifty into the stock, and you put $20,000 into three, and it goes to zero, you lose exactly the same amount of money—everything! People say, “It's three; how much can I lose?”

Well, if you put a million dollars on it, you can lose a million dollars! Just the fact that this is the only—this may be a reason to research a stock. The fact that the stock is three down from 100 doesn't mean you should buy it. In fact, short sellers—people that really make money in stocks—they don't short at Walmart. They're not shorting at Home Depot. They're not shorting at great companies like Johnson & Johnson.

They short stocks down from 80 to 7; they'd like to short it at 16 or 22, but they figured out at 7, “This company is going to go to zero.” They just haven't blown the taps on this thing yet; it's going to zero. And they're selling short at 7, they're selling short at 6, at 5, at 4, at 3, at 2, at one and a quarter. You know, to sell something short, you need a buyer. Somebody has to buy the damn thing.

And you want to—who's buying this thing? It's these people saying, “It's three; how much lower can it go?”

Now, here's a subject that you've probably all talked about getting—uh, close didn’t post. Alright, we'll drop that one out. It's getting very close. So, the important thing is you can't get too attached to a stock. You have to understand there's a company behind it. You can't treat this like your grandchildren, you know; you have to deal with the stock and say, “I understand the company,” that deteriorates at the fundamental slip. You have to say goodbye to it.

You have one rule you want to remember: the stock does not know you own it! This is a breakthrough! So don't get—you know, you have to understand it, and say they're doing well. As long as they keep doing well, my best stocks have been my fifth, sixth, seventh year I own them—not my fifth, sixth, seventh day.

So you have to understand that, and, uh, stay with it. Then I'll switch through to my long shots—avoid long shots! I bought about 30 long shots in my life; I've never broken even on one. The ones that are really bad are what we call whisper stocks.

If Arthur Levitt was here, I would appreciate these stories, but these are the times that somebody calls you up and says, “Hi Peter, how's Carolyn? How are the kids? I'd like to talk to you about, uh, International Blivet.” And, uh, they have very good products, and they keep whispering. And they say, “What are you talking about? I don’t understand.”

These are now either they’re so surrounded by people they're going to run out and buy this stock because it's so exciting, or they think the SEC is listening in. They'll get a shorter term, you know; they'll get six months in the camp rather than two years in the camp for. But whisper stocks don’t work!

And then I want to conclude with—there's always something to worry about if you own stocks. There's always something to worry about; you can't get away from that.

What happens in the 50s? People were worried that the only reason we got out of the depression was World War II. We got another recession in the early 50s. They said, “We're going to go right back into a depression.” People worried about a depression in the 50s and worried about nuclear war.

I mean back then, you know, the little warheads they had then, they couldn't blow up McLean, West Virginia, or Plain, Virginia, you know, or Charlestown. Now all these countries that end in “stan.” There are nine of these “stan” countries that have come out of Russia; they all have enough warheads to blow the world up, and no one worries about it!

When I was a kid, people were building fallout shelters, and we had this civil defense drill—remember this one in high school? You get under your desk. I never thought even then that was a particularly good thing to do because, you know, they blow it with some people—it had. We all get under our desk, you know.

But in the 50s, people wouldn't buy stocks. Except for the 80s, the 50s was the best decade of the century for the stock market, and people wouldn't buy stocks in the 50s because they were worried about nuclear war. They worried about re-entering the depression.

Then people—Marine Oil went from 4 to 40, and it was going to go to 100. "We're going to have a depression." Remember that one? Well, about three years later, the same experts! Now higher-paid oil is at 10! They said it was going to four, and we're going to have a depression!

Then the Japanese—remember the Japanese? “We're going to own the world.” Remember that one? And then we were going to have a depression! Then, about two years later, we were all worried about Japan collapsing! This is the most absurd thing I’ve ever heard!

It was a company with a 20 percent savings rate, incredible workforce, incredible productivity, and people were saying, “We're going to have a depression because Japan's going to collapse!” They, you know, on their prayer list they lowered Mother Teresa and triple children, and they were praying for Japan at night!

No, it's unbelievable. I mean the LDC debt—remember the LDC debt? Remember that one? All these countries—always chase that lent—lent their net worth to Brazil, Chile, Peru, and all these other countries. So ahead—these other countries and LDC said, “They're not going to pay it back,” and we're going to have a depression!

Always ends! And we’re going to have a depression! Or the Great Depression—we have the Great Depression! I never could understand that adjective in front of depression. But the—was the Great Depression or the Big One? The Big One's coming! But all these countries!

Now I understand—these are called—them were called less developed countries; now we call them underdeveloped countries. Those are all wrong terms. Those are not politically correct. You have to call these emerging countries! You can't use less developed or underdeveloped because it's—in fact, the other day I heard the politically correct term for something that's overweight is laterally challenged!

That's the, uh, that's a—so there's always something to worry about, and the key organ in your body in the stock market is your stomach. It's not the brain. If you can add eight and eight, get reasonably close to 16—that's the only level of math you need to know. You don’t need to know the area under the curve—remember that quadratic equation, and the integral calculus, and the area under the curve?

I mean whoever kid was under the damn curve but you had to study this. You don’t need this in the stock market! So all you have to know is you're going to see it's always going to be scary. There's going to be always something to worry about. You just have to forget all about it, cut it all out and own good companies, own turnarounds, study them, and you'll do well!

And that's all there is. I'm ready for questions.