A Stock-Picking Guru’s Simple but Sage Advice

Qualifications for Legend Status on Wall Street: 1) You made a lot of people rich, then retired gracefully. 2) You can still dispense sage advice on demand, and with a sense of humor. 3) You look like a sage.

Peter Lynch took a seat in Wall Street’s pantheon in April, 1990, when he retired after 13 years at the helm of the Boston-based Fidelity Magellan fund.

Through exceptionally savvy stock picking, the tall, snowy-haired Lynch built Magellan into the nation’s largest stock fund, with $13 billion in assets and one million shareholders.

But at 46, he decided that the 12-hour days and six-day weeks were beginning to wear. He wanted to watch his three kids grow up. Independently wealthy, he could afford to walk away. So he did.

Today, Lynch is one of Wall Street’s most entertaining and eloquent speakers. His advice to investors is simple yet powerful: Buy stocks of good businesses, and stick with companies that you know; invest long term; be realistic about your losers--everybody has ‘em.

Lynch addressed a conference of independent money managers in San Francisco last week. Excerpts from his talk, and from a private conversation beforehand:

* On the economy: “These bears who think the economy isn’t going to make it are going to be wrong.” The U.S. economy is simply reinventing itself, Lynch says, as many large companies scale back and new businesses come to the fore.

The process takes time, but it is creating innumerable future success stories, he says. “When three of us start a company, it never makes the front page of the paper. But it’s happening every day.”

* On broad market trends: Many of the stocks that made him rich in the ‘80s--including Merck, Wal-Mart and Coca-Cola--”are fairly priced or overpriced now,” Lynch says. The value today is in financial stocks, industrial stocks and small growth stocks, he says. “When business comes back, there’s going to be a huge boost in profits” at those companies.

* On individual investors: “I think people have more of an advantage today than ever because the market is becoming more and more dominated by institutions.” Institutions are slaves to short-term thinking, Lynch says, while individuals have the luxury of time and the ability to move nimbly. Focus on individual stocks, forget most of the rest, he says. For example, “Don’t try to predict the market or interest rates.”

* On picking stocks: Just buy companies whose businesses you understand and can monitor, Lynch stresses. Smart stock picking often is as basic as buying shares of businesses whose products you enjoy and respect. “You should be able to explain in a minute or less to a 12-year-old why you own a stock.”

But you must be willing to study your company and its industry, and stay abreast of the company’s progress, Lynch says.

“It always amazes me that people will look at six apartments (before renting) . . . they’ll do more research on a microwave oven before they buy than they’ll do before they buy a stock. If you don’t know what’s happening to your company, you’re really off to a rough start.”

Some investors shy away from investing in simple concepts, because they seem too obvious. Yet many of the most successful companies are based on simple concepts, Lynch says. “I want to buy a company that any fool can run, because eventually one will.”

- On portfolio size: Standard advice is that individuals must own at least 10 stocks, to diversify their risk. Lynch disagrees. If you already own stock mutual funds for diversification, he says, it’s OK if your individual stock holdings consist of only a few names-- if you understand them thoroughly.

“If you look at 10 companies, I think you’ll find one you like. If you look at 20 companies, you might find two you like. I think individuals should know eight or nine stocks, and own two or three.”

* On long-term investing: “Somebody invented this term ‘play the market,’ and I think that’s done more damage than anything else.” When Lynch says hold long term, he means it. “I’ve found that my great stocks (become great) in the third, fourth or fifth years I own them.” Take your time finding good stocks, and then take your time owning them, he says.

But the only reason to stay with a stock five years, he adds, is because throughout that time the basic story of the company’s growth stays the same, or gets better--regardless of the stock’s short-term gyrations. You also have to be realistic about your losers, and be willing to get rid of them when you know in your heart that they no longer make the grade, Lynch says.

* On his holdings: Lynch says he owns between 50 and 100 stocks at a time. About 25 are small savings banks and savings and loans, mostly in the Northeast. The attraction: They’re still out of favor with investors, but their bad loans are decreasing and their basic business is strong.

“Eventually, they’ll become plain vanilla thrifts again,” he says, making decent profits. Yet many of the stocks still sell for less than half “book” value, the theoretical value of their assets if all liabilities were paid off, Lynch says.

His portfolio includes West Newton Savings Bank in West Newton, Mass. ($7.50 a share Friday on NASDAQ); North Side Savings Bank in Floral Park, N.Y. ($10.50, NASDAQ); and Pamrapo Bancorp in Bayonne, N.J. ($17, NASDAQ).

Lynch’s other stocks include Chrysler ($27, NYSE), because of the perceived strength of its new car and truck lines; Citicorp ($17.50, NYSE), because he sees it mirroring the recovery of some of the once-crushed New England banks; retailer Pier One Imports ($10, NYSE), because he believes most of the company’s competitors are falling by the wayside; and hair-cutting chain SuperCuts ($11.25, NASDAQ), about which he says, “If I owned just 10 stocks like it, I’d be very happy.”

10 Things You Should Never Say Here are Peter Lynch’s “10 Most Dangerous Things People Say About Stock Prices,” and summaries of his rejoinders. 1. “If it’s gone down this much already, it can’t go much lower.” It’s never too late to sell if it’s a bad business that’s getting worse. 2. “If it’s gone this high already, how can it possibly go much higher?” When you’ve got a winner, you stick with it--like Wal-Mart through the ‘70s and ‘80s. 3. “Eventually, they always come back.” No, they don’t. Remember RCA, Manville, International Harvester, Western Union? 4. “The price is $3, what can I lose?” You can lose 100%. Don’t be tempted by long-shot, low-priced stocks; they almost never pay off. 5. “It’s always darkest before the dawn.” Never buy stock on the mere hope that business will improve. You need more reasons than that. 6. “When it rebounds to $10, I’ll sell.” Sorry, the stock doesn’t know you own it. If you’ve made a mistake, admit it and move on. 7. “What, me worry? Conservative stocks don’t fluctuate much.” Just look at IBM this year. 8. “I didn’t buy it, and look at the money I’ve lost.” Stop worrying about what you didn’t do--concentrate on tomorrow’s potential stars. 9. “I missed that one. I’ll catch the next one.” Don’t blindly buy clones of successful firms. They rarely duplicate the original’s success. 10. “The stock has gone up, so I must be right. The stock has gone down, so I must be wrong.” A stock’s short-term gyrations say little or nothing about its long-term potential. Only fundamentals matter.