Peter Lynch: How to Outperform the Market

Trying to predict the market is really a waste. I don't know what's going to do; it can go down. When I ran Magellan, 13 years declined 10 or more nine times the market. Wow, I had a perfect record; I went down more than 10 every time where the market went down and went down more. But over the long term, the upside is more than the downside.

Your investing philosophy is often summed up as "buy what you know," and there's some truth to that. And it's also often way oversimplified. Can you explain what you did mean by that and what you didn't mean? Well, it bothers me that people are very dangerous when they invest. This word "play the market" is a dangerous term. But if you do some work, do some research, know what you own, look at the research, look at the balance sheet, if you could add 8 and 8, get fairly close to 16, you find out this company has lots of debt, no cash; they're in trouble. You should know it.

So, a little bit of research. People carefully buy a refrigerator, can they take a vacation? And then they'll put five or ten thousand dollars some stock they hear about on the bus or at the party. That's dangerous. So when you say "buy what you know," you also thought that the regular investor might be able to get an inside advantage by sticking to an industry he's familiar with or seeing something that she realizes is a great product.

Imagine if you were in a mall the last 50 years; you were seeing Gap when it was hot. You were seeing aluminum was hot. We've seen when they were starting; people weren't excited about Gap anymore. Or then you do some research and say, "Well, gee, there's a lot of limited stores, but we're only at 20." You know they go to 400. So you see a company. I did really well with Dunkin' Donuts, a local company. I do well with Stop and Shop. But people can see that there's really some people showing up or guess the Sunglass Hut; no one's there anymore.

So, I mean, that's research; that's fundamentals. So you don't leave the mall though and buy that day. You have to do some more work; that's the important point.

Yeah, so today there's so much information everywhere. Information overload—does that make it harder for active investors? The indexers say everyone's got access to the same information at the same time; you can't beat the market.

Well, the way you beat the index is you avoid the stocks that go down. You avoid the steel companies and the oil companies and Sears and Penny, and where the companies are deteriorated. I mean, companies are dynamic. Behind every stock, there's a company; these are not lottery tickets. So you're trying to find the companies within the S&P 500 that are doing better. They're going from crappy to semi-crabby to good; that might take a couple of years, or they're going to grow for a long time, and you're trying to avoid the companies that are going south.

That's how you beat them. Or you find some companies outside the S&P 500 that are great companies. CarMax was not in the S&P 500; they weren't 200-fold. So a lot of times they enter, and a lot of their great performances before they go in. Now, a lot of people, when they're lucky enough or smart enough to get a company that's going up, they then take their profits.

And you made the case in a book that you should actually hang in there with the really great stocks. You even got a call from Warren Buffett as a result.

Yeah, in 1989, I'm at home, and the phone rings, and that was one of my friends, but one of my daughters, your six-year-old, and he picked up. She just says, "There's a Mr. Buffett online." I said, "This could be a joke." I pick it up, and this is Warren Buffett from Omaha, Nebraska. You know, I read your book, but my AIM report's doing in two weeks, and I use a line you said about seven seconds.

I said, "That's great; I'd love to do it. What’s the line?" He said, "I love this. I've been waiting to do this: when you sell your great companies and add to the losers, it's like watering the weeds and cutting the flowers." He said he wanted to put it in. He said, "If you ever come to Nebraska, don't call me; you nailed me; mud all over Nebraska."

So did he call him?

Oh yeah, several times; we played bridge together; we've had several meetings. Great guy.

Another point you've made, and this is, I think, particularly relevant 10 years into a bull market, is that I think you said more money has been lost anticipating a downturn than actually in the downturn. Can you explain?

Well, obviously, the market's gone up tenfold since I stopped running Magellan. You make more money on the upside. The market's been a lot higher in 10 years from now, 20 years from now, 30 years from now. Trying to predict the market is really a waste. I don't know what's going to do; it can go down. When I ran Magellan, 13 years declined 10 or more nine times the market. Wow, I had a perfect record; I went down more than 10 every time where the market went down and went down more. But over the long term, the upside is more than the downside.

So you've got to say something: do I need the money in the next month? Do I need money next year? Do I have kids going to college? I have a wedding coming up? Then you're a bad investor. If you can keep putting money in for 5, 10, 15, 20, 25 years, you should do well.

One thing we're thinking a lot about at Barron's is the secular changes we're seeing in the market where there's so much disruption that we wonder if certain industries, they may be cheap, and they may just keep on getting cheaper. I mean, retail would be an obvious one in some cases, victims of Amazon. But even the auto industry, very low price earnings multiples, maybe the market sees something.

Do you think secular changes are moving more rapidly now than it did in the 80s when you were running money?

No, I saw the textile industry deteriorate. I was recommending all the stocks on the way down. I saw the shoe industry go away; industries can go from terrific to terrible. There's a great expression: the intentional industry—that helped me a lot—textile industry. Yeah, it's always darkest before pitch black. Just anything, things are terrible; they get terrible squared.

I mean, so just because the industry's getting bad, that's not a reason to invest. Wait for things to get better because, again, somebody might be involved in distilling; it might be involved in coal; it might be involved in iron ore; they might be involved in plastics; they'll see aluminum pick up before I do. So you might—that's a cyclical turnaround that might last two or three years; you might see way before Wall Street sees.

One broad area that you've recently said might be interesting is energy, and it's very unloved on Wall Street right now. What do you see in there?

Well, the difference between a glut right now and a shortage is like 1 million barrels a day. You know, the world consumes 100 million barrels a day—1 million each way. So if the economy stays okay, and these shale wells do a thousand barrels a day the first month, a year later that's 300. Wow, then they're 150—a big drop-off. It's a real treadmill.

And right now, there's no private equity money; there's no IPOs; there's no bond market. The banks want out; private equity wants out. Shale's going to slow down. So these people think the chair is going to keep growing 2-3 million barrels a day. We've gone from 5 million barrels in the U.S. producing to 12 and a half. People think that's going to continue; I don't believe it will.