Saturday, December 23, 2006

Peter Lynch's One Up on Wall Street

One of the first books I ever read about investing was Peter Lynch's One Up On Wall Street.

For those of you who have never heard of Peter Lynch (wikipedia), he ran Fidelity's Magellan fund from 1977-1990 and put together one of the most enviable fund manager records of all time. The fund showed a CAGR of approximately 29% during his tenure, and he only underperformed the S&P twice.

The first 80 pages alone are worth the price of this book, and if I taught a course in investing, I would be sure this section (Part I: Preparing to Invest) was required reading. The ideas in these chapters form the foundation of a sensible investment philosophy.

Chapter 4, Passing the Mirror Test, has a particularly useful exercise for anyone who is thinking about investing. Lynch suggests that you stop, look at yourself in the mirror, and ask these three questions:

1) Do I own a house? Lynch suggests that you buy a house before you invest your money in the stock market because, "in 99 cases out of 100, a house will be a money-maker." The way he sees it, a house is rigged in your favor. You can acquire one for 20% down (without having to make the cash call like you would with a stock bought on margin), the leverage you use increases your returns, and the interest on the loan is tax deductible. In addition, people generally do more research when they buy a home than when they buy a stock, which further increases the chances that the investment will turn out well.

2) Do I Need the Money? I think this is the single most valuable piece of advice someone will ever give you about investing. Lynch says the formula for figuring out what percentage of your assets should be put into stocks is simple: "Only invest what you could afford to lose without that loss having any effect on your daily life in the forseeable future."

I can't say it any better myself. The stock market is not magic. If you need to pay for something within the next five years or so (such as a new house, college tuition for a kid, etc...), do not put that money into the stock market because there is no guarantee that it will be there when you need it.

3) Do I Have the Personal Qualities it Takes to Succeed? Lynch says that this is the most important question of all. The personal qualities he lists as necessary for success in the market are "patience, self-reliance, common sense, a tolerance for pain, open-mindedness, detachment, persistence, humility, flexibility, a willingness to do independent research, an equal willingness to admit to mistakes, and the ability to ignore general panic... It's also important to be able to make decisions without complete or perfect information... And finally, it's crucial to be able to resist your human nature and your 'gut feelings.'"

After setting out this foundation, Lynch moves into Part II - Picking Winners. He takes the reader through a process they can use to discover undervalued stocks on their own, and continually stresses that people should exploit any edge they have to identify promising companies. He says to stay on the lookout for things that are happening at your company, stores that seem crowded, prices that are going up, products that are in demand, and you might notice something before Wall Street does. For example, "You don't have to be a vice president at Exxon to sense the growing prosperity in that company, or a turnaround in oil prices. You can be a roustabout [ed note: whatever that is], a geologist, a driller, a supplier, a gas-station owner, a grease monkey, or even a client at the gas pumps."

Once you've located an opportunity, Lynch walks you through the next steps in the research process, from looking up the financials, to calling the company for more information, and ultimately, deciding if it is worth buying.

I'm not a fan of picking your own stocks, unless you are really willing to put some time into doing the research. If you do choose to get into this, however, this book would make an excellent addition to your shelf.

As an added bonus, it is extremely easy to read. There are no boring parts, and Lynch has a somewhat light-hearted style.

Lynch followed this book up with "Beating The Street" where he went more in-depth about specific stocks that he selected and why. If you liked this book, "One Up On Wall Street" would make a logical next read.

No comments: