Peter Lynch – How To Invest With Stocks At High Prices

Speaker 1: Peter Lynch was one of the smartest investors that the world has ever seen. He got a return of twenty nine point two percent while being an investment manager of the Magellan Fund, making it the best performing mutual fund in the world. In this video, I’m going to show you a clip of Peter Lynch talking about high stock market prices and what to do.

Speaker 2: Is highly regarded as one of Wall Street’s legendary money managers, he ran Fidelity’s Magellan Fund from seventy seven to 90 at the end of his 13 year helm. It was up over twenty seven percent and had become the world’s largest mutual fund. He remains on the board of trustees at the Fidelity Group and is vice chairman of Fidelity Management and Research. His new CD, ROM, is called The Stock Shop with Peter Lynch and its strategy to invest in the stock market with confidence. All the profit for this go to charity, I think. He joins me now to talk about the remarkable record volume day on Wall Street and other matters of investing. And I am very pleased to have him back at this table. Welcome back.

Speaker 3: Hey, Charlie. Good to smart of me.

Speaker 2: Smart of me to schedule you on a day like this. Three months ago, I said, what do you want Lynch to come in? And I said, let’s get him on Tuesday. Something’s going to happen in the market that week. And so here we are. Glad to be here. Explain to me what’s going on.

Speaker 3: Well, we had a huge run. I mean, the market was four thousand just two and a half years ago and it ran up to eighty three hundred in August. And, you know, like any big rally, sometimes it backs off. I mean, it’s healthy. In fact, I mean, I’d rather gone down a thousand points than gone to twelve thousand. If you look at Japan, Japan, one from five thousand fifty thousand on their Dow and it was fairly priced at fifteen thousand on earnings and everything else then went to forty thousand and that caused seven years of inflated real estate people overspending. And basically they’ve been in recession for five or six years because the market went up too high. I mean the market was up too. I mean, if the market goes too high, you’re discounting earnings seven, eight, 10 years out.

Speaker 2: Everything is overpriced.

Speaker 3: Yeah. And that doesn’t help anything. The market since World War Two, it sold between 10 times earnings and 20 times earnings. If you look at the Dow Jones or the S&P 500, you add up all the companies and take the earnings. You see there’s a relationship and it follows. McDonald’s earnings have been terrific the last 30 years. And the stock’s metric, there’s a direct relationship. So the earnings of the S&P, five hundred have been between this range of 10 and 20. We were just about to go over the 20, which is the high end of the P range. There wasn’t a loss of

Speaker 2: twenty is two. Is it the type high it should ever be? Right.

Speaker 3: It’s been over there only a few times, ever over twenty. And that’s when usually inflation’s about zero. In the early sixties, when inflation was about zero, we got a little bit over twenty. Now we a very low inflation rate. So if you really have subtracted inflation from twenty, you’ve had the P the market. That’s been a pretty good ratio. When inflation was twelve percent, you remember in the early eighties with eight or nine P market.

Speaker 2: So Dr. Lynch says all of this has been good for us. Well, it’s

Speaker 3: like I’m telling you, would not have been helpful is like a purgative. I never thought I’d ever wish for the market to not go up dramatically. But let’s just let’s argue the market went to sixteen thousand tomorrow. Yeah. Basically, there is earnings behind companies.

Speaker 2: OK, but I’m not arguing that I know that’s true. And stock market price ought to be dictated by earnings and earnings performance and future earnings potential. That’s right. That’s right. I got that even I got that right. Now, let’s just take this for me. Was the decline yesterday in a sense, it led off some of this overvaluation. The market was even overvalued to where it was. And by letting it off right then we got back to what was reasonable,

Speaker 3: I would say fairly priced for the larger companies. They’re now OK. There might be some small companies mean we’ve had three thousand companies gone public the last four years. That’s a to a business day. Some of those companies have gone down dramatically. And that’s sort of a research zone that average people and the stock shop that we can find. Some people know a lot about this. Ten thousand public companies, a lot of them are very attractive. No one’s following. And there’s lots of people on IBM, let’s

Speaker 2: call it companies that nobody else followed.

Speaker 3: Right. I’d like to go to see comes with unions or comes in trouble or companies that no one looks at

Speaker 2: deals that had nice

Speaker 3: beds. Yeah, yeah.

Speaker 2: A lot of you look who’s your wife?

Speaker 3: What can you get? Pier one imports. My wife and I went to it, but you have to look at twenty to find one. It’s just you go to the mall and find the stock. I mean you have to say, oh my God, this sounds like it’s good. Then you have to do some steps. You have to do an organized method. People are careful when they buy a toaster, care for their careful. They they do they do some research,

Speaker 2: but they don’t do it with stock. It’s called the broker. They see somebody at lunch. And I said, man, I got this hot stock and you run right out and you spend five thousand dollars. Small investors.

Speaker 3: Yeah, a more secure an option. International data where they don’t even own internationally. So it’s 90 days, but

Speaker 2: it was good and they make a lot

Speaker 3: of money and it’s and it’s like a casino. So it’s like a casino. You get the same results as if there’s more people.

Speaker 2: But just stay with me in terms of people who are bedazzled by what’s happened. Right. If you look at yesterday and you look at today, nothing has happened in the fundamentals of economics of any company. Right. Right. But their stock may have gone down 10 percent yesterday and up five today.

Speaker 3: One modest point. Do I mean, every time you get you have to get memories. That gets very cold in the winter. In some parts of the country, you get a memory. That winter’s coming. Something did really happen in Southeast Asia. I mean, those did the

Speaker 2: economies of what happened in this

Speaker 3: market. I think so. That was the reminder by the world. You know, profits can go down. I mean, there is a downside.

Speaker 2: But why was that the cause? I mean, what’s happening in Southeast Asia affect the earnings potential of all these companies you’re talking about because they can’t sell their products.

Speaker 3: They’re small, we know, because those economy’s been growing double digit. And all of a sudden now they’re going to because of bank problems, because they’re over financed. They’re under I mean, they’re going to have they’re going to have to run their belts. Those and then people said, whoa, maybe that’ll become it’ll happen. China is now the fourth largest economy in the world. Maybe China can go on recession. So this sort of woke people was like a wake up call saying, whoa, maybe there’s a chance earnings going to out. I mean, this is. Not a big deal for the United States when Mexico went down, much more important, but it sort of said people have is much more important

Speaker 2: to Mexico

Speaker 3: for the United States than Thailand is or the Philippines or their economy is very important to us. There are big consumer, very important. There are neighbor, a lot of people there. That’s a very important when that went down that affected Latin America was more important. So the recession, nighty night. But it sort of reminded people that say, wait a second, there is a downside. We have we’ve had nine recessions since World War Two. We’ll have other ones.

Speaker 2: Tell me what took place overnight between yesterday at the close of market and today at the beginning. Where were the guys that you used to work with saying to each other at Fidelity? And what were the people, you know, saying, for example, IBM made a decision to buy back their stock and that presented some kind of push on the market and their stock went up six points.

Speaker 3: Well, one thing you’re trying to do is take all these public companies out there. Here’s a company I really like. The fundamentals are terrific. Their earnings are doing well, their competitors are doing poorly. I think this company’s doing terrific. And all of a sudden, the stock might have gone from 40 to 30 because of this decline. That would say, wow, here’s a chance to buy it. So you’re trying to say some companies might have been overpriced at 16. All they did was go to 50 and say big deal. So you’re trying to find jobs you liked anyway, right now you liked them and now they’ve had a haircut. That’s what you would do. Not not a stock from overpriced to fairly standard fare in place at the start of this exercise and then had a very, you know, of five or for sale.

Speaker 2: If you had been managing the Magellan Fund this morning, you would have been buying like crazy.

Speaker 3: I would’ve been researching like crazy. I would’ve been saying, which companies are the same story? Is there anything really this is a nonevent for them? They’re still doing well. Even if we have a recession, there’s nothing to do with them. And that’s the kind of kinds of trying to buy. But let’s say if I just think of it, this is being you say to yourself, I think this company earned something in the future. If it’s already discounting that, if it’s selling at a huge multiple, you say it’s all it has to work and then it’s only going to stay even. So you have to say stuff. If I’m right, how much am I going to make if I’m wrong, how much I’m going to lose? That’s a risk reward ratio and stock shop we talk about. If I’m right, I hope I can double my money. If I’m wrong, they’ll lose 30, 40 percent. That’s a favor ratio. We say if I’m right, the stocks have to go up. It’s already discounting terrific things. If discounting terrific things. Are we in the stock?

Speaker 2: I don’t know. OK, so this morning you get up and you go in and you look at those companies that do

Speaker 3: that, you know something about you have to have an edge. I mean, let’s say a cement industry goes from crummy to semi crummy to fairly good. The stocks are going north. You’re going to make money. That’s the interest. You know what? If you know the publishing industry, you some people, you have an itch, you work. I mean, one, if you last thirty years, you work in the restaurant, you want to see Taco Bell, some you were seeing Pizza Hut, you’re seen Chili’s. You see these companies doing very well. You should have bought those instead of trying to buy biotechnology stocks. You know nothing about. I mean, I know nothing about local area networking. A lot of people are buying the Cisco. They’re buying the equipment saying we’re going to route together all these peripherals. You can put together the servers.

Speaker 2: But but that’s not a bad buy because they own a huge percentage

Speaker 3: of their market. Know what that was? They’re saying only a few people have the money to. My God, if it works for us, other people try it. Then colleges will try at high schools to try it. Then we’ll go overseas. They knew they were early in the ballgame and they should’ve been buying that company instead of out buying something they don’t know anything about. Some oil drilling company IPO, this tendency to always buy something they don’t. All the needs of you, all you need is a few good stocks. This is your

Speaker 2: song. This has been your song for a long time. But here’s what you know now.

Speaker 3: What people wake up the morning and say this. Five thousand companies out there, which one should I buy? The average person ought to be able to follow four or five companies to be a lecture on. They understand the companies and this forces you. This tool says you write down the

Speaker 2: you keep saying this. The stock shop is what what is it? This is a CD rom that you plug into your CD rom and play through your PC and you come up with,

Speaker 3: well this is a data stream. You can update information or five or six thousand copies. Right like that. You can get ten years of financial data, ten years of income statements and use inventory so you can get updates and all these companies,

Speaker 2: what you get on a Bloomberg terminal.

Speaker 3: But it’s only right now and it doesn’t pick fifty data points. It doesn’t go over five years. This comes you want to look at. I’ll give you all the information out of this. It cost sixty nine, six dollars and ninety five cents a month in addition. And it’s you get to see you get a free trial. We’ve going to cut a great deal and you can also buy it. You can get it from fidelity for special programs. But this is something this will help you update it so you can say this company want to look at it and see what are the cash looks like. And if you don’t estimate caches, if you understand what debt is, I always said, let’s say you’re looking at companies that are doing poorly. They’re not doing very well. Why don’t you buy the one that has three million dollars in cash and save the one that’s almost bankrupt? I mean, a lot of companies are selling two or three dollars a share. They might be losing ten million dollars year in it, but people don’t do it

Speaker 2: because they don’t know how to do the research.

Speaker 3: You can look up the balance sheet, say, let’s say they got three million dollars in cash flows in ten million a quarter. They’ll be OK. This other companies got no no cash, seven trillion dollars in debt. They’re about to blow taps.

Speaker 2: But you telling every small investor in America anyway, they invest in a mutual fund, aren’t you?

Speaker 3: I’m telling you could do both. You ought to be investing mutual funds and occasionally you should be able to find stocks can make a difference in your life.

Speaker 2: If it’s an industry, you know, something about

Speaker 3: industry or local company. It’s a lot of people that they saw the Kinta trends in Texas. They said, my God, I mean, a lot of you have seen local companies so friendly. There’s a company come along locally. The people at St. Jude Medical made a lot of money for

Speaker 2: people who was at motel. You stayed in and then you went and bought a bunch of it. Was that that’s what it was. You stayed overnight there.

Speaker 3: I got advice from somebody that was a competitor. This is a Holiday Inn guy saying this guy, but they’re killing us. They’re tough, you know. So now you get a lot of information. Don’t throw it away. All right.

Speaker 2: Before you go. So what, you buy this thing and is it going to charity or not?

Speaker 3: Well, all my profits. I mean, Houghton Mifflin is the person marketing this and they’re keeping some profits. You haven’t made them charitable in the company of the company that’s selling the you’ve got a borders or you got to say they’re not their name. Everything I’ve done all my books and on this, my wife and everything.

Speaker 2: Is this because you made a bunch of money. And so therefore, what you do now, you will be

Speaker 3: that’s part of it. But also, even if I hadn’t made much money, I’d like to see people do a better job. These are people I used to be when you used

Speaker 2: the your crusade is to influence the investing habits of America

Speaker 3: to help do a better job. If they’re not ready to do it properly, they shouldn’t do it and used to be used to retire. And you get half your last year’s salary. You’d have a pension. You can rely on it now. You have to do it for yourself. Some people presented there, they’re let go. But in early retirement, they’re given five or a thousand dollars and they say this is it. This your retirement lady. You’re got to take care of it now. And some people have lost all their money and options in the last three years.

Speaker 2: So what you’re saying to people today about the future of the market over the near term is what what’s your feeling we can take out to buy

Speaker 3: because we can take a coin out and flip it? I have no idea what the next thousand points are going to do. The next six thousand points going to be up the next fourteen thousand points, maybe up the next twenty thousand points up. But you don’t

Speaker 2: know where the next thousand is going to be up.

Speaker 3: Nobody does. And it’s futile to try and guess it. Corporate profits will be a lot higher ten years from now. Will it be a lot higher twenty years from now? That’s what you could rely on. Microsoft didn’t exist twenty years ago. Staples did exist twenty years. Federal Express did exist twenty years ago. New companies will come along. That’s what makes it twenty years ago. That’s what makes. Amgen has two one billion dollar drugs. They didn’t exist twenty years ago. New companies to come along. That’s what makes this country work. You’re going to keep your eyes open.

Speaker 2: Is the game over in Asia?

Speaker 3: No, God, no, you can’t. You know, some countries have a fifty six percent savings rate. They have high literacy rates came down over there. They’re going to have to.

Speaker 2: Have they lost something?

Speaker 3: Well, they’re going to have to have some of the lending they got carried away. I mean, they’re going to have to step back, figure it out and go ahead. It’s certainly not over in Asia.

Speaker 2: No way to emerging markets is still a big deal. Right. What about all the criticism of derivatives and the impact they have had?

Speaker 3: That’s a little complicated for me. All I know is, I mean, I don’t know if I can it for you. It’s way over my head. I’ve never bought the option in my life. I know. But your time’s on your side when you own a stock, you know, I don’t know, about three percent down and buying a future in a scrap in astraddle. That’s where my head can’t do it. Right. Somebody else deal with it.

Speaker 2: All right. So you’re optimistic about the future of the American economy? Earnings potential for most well-run companies will do all right.

Speaker 3: But people have to understand, we’ve had nine recessions since World War Two. We’ll have other

Speaker 2: recession, but we’re not in one now.

Speaker 3: But we may have one in the future and don’t get worried. It will happen sometime. It’ll happen and no one will tell you what it’s going to happen.

Speaker 2: It’s what the fundamentals tell.

Speaker 3: You know, you’ll find out after the fact. You’ll all of a sudden you’ll notice orders slowing prices get more competitive than earnings are down. I mean, usually you find out that no one declaring rates and saying we’re going to have recession for five years. It just hasn’t happened.

Speaker 2: It’s great to see you. Hope you’ll come back any time, Peter.

Speaker 3: Excellent. Thank you. Thanks.

Speaker 1: One of the first things that you’ll notice in the interview is they talked about market p e ratios. Whenever the market gets to a p e ratio above twenty, you need to be on your toes. Now, that’s exactly the market that we’re currently in. The S&P 500 is well above that swanzy mark. Now, that means prices are high. There’s no doubt about it. So the question is, how do we invest in these conditions, as Lynch talked about in the interview, buy good quality businesses that are outperforming their competition. These are the ones that are going to survive a potential crash. Secondly, check their balance sheets are stable and preferably have a little bit of cash on them for tough times. Then you’ve got to understand the company that you own. You know, you wouldn’t buy a local business in your town if you didn’t understand it. And it should be the exact same thing with a publicly traded stock.

Lastly, remember that good times only lasts so long, so just make sure that you are prepared financially and emotionally for if a crash does happen because most people aren’t prepared for one. And if you are, well, you’ll beat most investors.

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