Peter Lynch: The Secret to “Buying the Dip"
Anyone that's been following this channel knows that I'm a huge fan of Peter Lynch. Lynch rose to prominence running the legendary Fidelity Magellan Fund and writing books such as "One Up on Wall Street," one of my top five favorite investment books of all time. Over his 13-year career running the Fidelity Magellan Fund, the fund averaged a nearly 30 percent annual compounded return, meaning one thousand dollars invested in his fund turned into over thirty thousand dollars in little more than a decade.
With a track record like that, it is clear that if you want to learn more about investing, you should be learning from Peter Lynch. These impressive results are the reason I frequently incorporate lessons I have learned from studying Peter Lynch both in my personal investing and in my job as an investment analyst at a large investment fund based in New York City. In this video, we're going to watch one of my favorite clips of Lynch, where he talks about how one of his best investments came as a result of buying the dip, as opposed to panic selling.
After the clip, we're going to break down this strategy and talk about how I applied the strategy to find an investment that made me over three times my investment over the past two years. The ultimate goal is for you to apply these investment lessons in your own portfolio. But first, make sure to like this video and subscribe to the channel if you aren't already, because it is my goal to help make you a better investor by studying the world's greatest investors. Without further ado, let's dive in.
"Excuse me, there's 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's going to 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. A lot of people bought on that basis saying, 'Look, it's got 135 to 100, it's now 95, what a buy.' Within a year it was 18. And this is coming with no debt. I mean, as it comes, 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 share to 16. I said, 'How much lower 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 is it going to go?' Well, at 10 I called my mother and said, 'Mom, you're going to look at this Kaiser Industries. I mean, how much lower can it go? It's gone from 26 to 10.' Well, it went to six, it went to five, it went to four, and it went to three. And, unfortunately, rapidly, I would probably be still caddying or working at the Stop and Shop, but it happened fast.
"I was able to, this was compressed, and at three, I figured out, you know, there’s something very wrong here because Kaiser Industries owns forty percent of Kaiser Steel. They own forty percent of Kaiser Aluminum, they own thirty-two percent of Kaiser Cement, they own Kaiser Broadcast, and they own Kaiser Santa Gravel, 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 some people. It's very hard to go bankrupt if you don't have any debt. It's tricky. Some people can approach that; it's a real achievement. But they had no debt, and the whole company at three was selling at 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 Aluminum, they passed out their public shares in Kaiser Steel. They sold all the other businesses, and you’d get about 50 a share.
"But if you didn't understand the company, if you're just buying on the fact that the stock had gone from 26 to 16, and then it got to 10, what would you do when it went to nine? What would you do when it went to eight? What would you do when it went to seven? 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 that the psychological psychiatry fund. I've never seen for the SEC to make it through as a mutual fund. So they haven't seen the help.
"I've tried prayer; that hasn't worked. 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 gets 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 the stock at three. How much can I lose?' Well, again, you may need a piece of paper for this, but if you and if you put twenty thousand dollars in a stock at fifty or your neighbor put twenty thousand at full at fifty into the stock, and you put twenty thousand dollars into three and it goes to zero, you lose exactly the same amount of money—everything.
"And 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 researchers thought the fact that 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 don't short at Home Depot, they're not shorting the great companies like Johnson & Johnson. They short stocks down from 80 to 70. They'd like to short it at 16 or 22, but they figured out at seven this company is going to go to zero; they just haven't blown taps on this thing yet. It's going to zero.
"Let's take a second to break down the situation Peter Lynch faced when he invested in Kaiser Industries because once we do, it'll help you understand why Lynch was able to have the courage to buy the dip in the company's stock price instead of panic selling when the stock fell in value. For background, Kaiser Industries was a conglomerate. Put simply, it was a large company that owned many smaller companies. Kaiser Industries owned companies such as Kaiser Aluminum, Kaiser Steel, and Kaiser Cement. Lynch was able to identify this company as undervalued and as an attractive investment. He bought a large amount of stock at 14 a share.
"However, after the purchase, the stock price continued to fall pretty substantially all the way to three dollars a share. Why did Peter Lynch not panic sell like most investors did at the time, and why did he even go as far as to encourage his own mom to buy shares in the company? It is because he truly understood what the company did and continued to believe the underlying fundamentals of the business remained strong despite what happened with the stock price. This is why he continued to buy more and more shares as the price fell.
"Once the company hit its low of three dollars a share, the company was so undervalued that the management of the company was forced to dissolve the conglomerate and distribute the businesses that it owned to the people that owned the shares. For every 100 shares a shareholder owned of Kaiser Industries, a stockholder got 25 shares of Kaiser Aluminum, 13 shares of Kaiser Steel, and 7 shares of Kaiser Cement. Once this happened, the value of the company increased dramatically, making this investment one of Peter Lynch's most successful investments of all time.
"Here are the main takeaways for investors: 1. Truly understand the company behind the stock you own. If you view stocks as companies with underlying business fundamentals, as opposed to just pieces of paper that float around in price, you will be more comfortable with price fluctuations. This leads me to my second main takeaway: if the underlying fundamentals of the business remain unchanged but the stock price is declining, that could be a sign of a great buying opportunity—either to start a new position in a stock or add to your holdings in that stock.
"One of my most successful investments in my stock portfolio came as a result of following this strategy. I had been following Apple closely for years and viewed the company as one of, if not the most dominant business in the world. Apple customers have immense brand loyalty, and the company is highly profitable with a strong ability to generate cash. Additionally, the company is growing its high-margin services side of the business. Apple had been on my watch list, but I didn't purchase the company because it wasn't undervalued. That was until a pullback in the stock price in late 2018 and early 2019 allowed me to purchase the stock at a huge discount.
"Apple's stock had sold off because of disappointing iPhone sales in a couple of quarters. Short-term focused investors suddenly didn't want to own this great company and sold their shares, causing the stock price to fall. However, I still knew that the underlying fundamentals of the company remained strong. Long-term demand for the products remained solid, and the company saw a bright and very profitable future. Because of this, I viewed this pullback as a strong buying opportunity and invested 40% of my portfolio into Apple stock.
"Without following the lessons I learned from Peter Lynch, I wouldn't have had the conviction to buy the stock during a significant pullback in its stock price. Because I understood Apple as a company, I saw the disconnect between the fundamentals of the company and its share price. Since my investment, the company's stock price has rallied more than 400 percent.
"So there we have it. Thanks for watching, and I hope you enjoyed the video and learned something useful. Make sure to like the video and subscribe to the channel, because it is my goal to make you a better investor by studying the world's greatest investors. Talk to you soon."