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Sunday, November 07, 2004 - Page updated at 12:00 A.M.
Q&A with legend of mutual funds: Long-term view key, Lynch says
By John Waggoner
Peter Lynch earned his place in the investment pantheon thanks to a spectacular, 13-year tenure as manager of Fidelity Magellan.
Lynch drove the fund to a 2,700 percent gain from May 1977 through May 1990 an average annual gain of 29.2 percent.
Magellan became the nation's largest stock mutual fund, a place it has since ceded to the Vanguard 500 Index fund.
Running Magellan took its toll. Lynch worked late nights and weekends, leaving home at 6 in the morning and leaving work at 6 in the evening. At 46, the same age at which his father died, Lynch stepped down to spend more time with his family.
He's now a vice chairman of Fidelity Management & Research, Fidelity's investment arm, and a member of the funds' board of directors.
He's also an adviser to Fidelity's stock analysts, but still manages his own portfolio and sits on several charities' investment committees.
Q: What has changed in the market since you've stopped running Magellan?
Merck's earnings stopped going up, and the stock went down.
I was at a luncheon three or four years ago, and Michael Dell was speaking. Someone asked, what do you think your stock is going to do? And he yelled out at me, "Mr. Lynch is very good at that."
So I said, if your earnings are higher in five years, your stock will be higher; if your earnings are lower, your stock will be lower. That's the way it works.
People concentrate too much on the P, but the E really makes the difference. (A stock's P/E ratio is its price divided by its previous 12 months' earnings. Stocks with low P/Es are considered cheap, relative to earnings.)
If companies have bad earnings, stocks do poorly. If earnings go from crummy to mediocre, stock usually goes up. If it goes from mediocre to very good, it goes up.
Information is a lot more available. When companies publish, you get the balance sheet instantly. You used to have to wait until they mailed these things to you. That's the only difference from five or 15 years ago the information is better, and it's current.
Q: A lot of people are sitting on losses of 20 percent or more from the bear market. What would you say to people who bought a good stock, the company's earnings are OK, and they're still down the past five years?
A: The question is, did everybody put their money into the market in March of 2000, or did they buy in 1995 or 1992?
If you measure from the peak, the market is lower. Did everyone go to their bank in March of 2000 and decide to buy a bunch of funds? It didn't seem that way. That was just a blowoff, some stocks were overpriced at $50 and went to $150. It's one of those crazy things you'll tell your grandchildren about.
The worst 10 years in the last 100 years of the stock market were 1928 to 1938, and you only lost 1 percent a year. That was a pretty ugly period. I don't predict the future, but I am a historian, and the stock market has been a pretty good place to be if you have a 10-year, 20-year horizon. Time is on your side. Two years is a short period. Four years is a short period.
People said I was timing the market when I left in May of 1990. In May of 1990, the Dow was at about 3,000. What was it at its peak? Nearly 12,000. That's how great I was at predicting the market.
Basically, we've had profits double, and the market has shrunk. The market was once 35 times earnings. It's about 17 now.
Usually, if you subtract the inflation rate from 20, you get the P/E of the market. On that basis, with inflation at 2.5 percent, things seem to be OK on the P side of the equation, so you have to make an E bet. And I think 10 years from now, 20 years from now, the companies that make up the Standard & Poor's 500-stock index will be earning a lot more money.
Q: How do you know when to sell?
A: I remember a company that this fireman owned, and he had a system. He made $400,000 on a $5,000 investment. He held it for 25 years. And he said, "As long as they keep hiring, I'm going to hold on to it. When they stop hiring, I leave." So when they stopped hiring, he sold.
Whatever reason you buy a stock is the reason you sell it. I owned Subaru once. They had a perfect niche. There was no one else in their market, had a great share, a superior car.
Then the yen went up, and they had to raise their price. Chrysler introduced a low-end car, and Ford introduced a low-end car, and they were good cars. All of a sudden, Subaru had competition and guess what? The stock wasn't a buy anymore. You should write down why you own this thing, and if that isn't true anymore, that's the reason you sell it.
Q: You mentor Fidelity analysts now. What do you tell them?
A: Most people who get to Fidelity have had a lot of A's in their life. They always have the perfect answer. But the stock market gives a lot of F's. Generally, if there's a lot to be made in the stock, somebody doesn't like it, and there are a few problems with it.
It's not like the company will have discovered a new product, have a wonderful balance sheet, and they just discovered oil on their property. Only a couple times in your career, everything falls in line.
It's a passive business. You're like a referee watching a soccer game, and you can't affect the game. You can't make Chrysler sell more cars. You have to look at what's there and report what's happening.
Q: What areas of the market interest you most now?
A: Generally, growth over value. Value has destroyed growth the past two or three years. I could be dead wrong, I could be a year early, but growth is more attractive to me than value. Over time, people have made money in value stocks, and in growth stocks. When one outperforms the other for a long time, you're better off to look at the one that has been underperforming.
Q: Any argument for preferring international stocks over U.S. stocks?
A: If you want to research some emerging markets, you can find big firms with low P/Es. I'm not recommending them. What you don't want to do is go into an emerging market and buy a secondary company, or a real flaky company. That's really dumb. But that's how John Templeton did really well, buying great companies in emerging markets. When he was buying in Japan, it was an emerging market.
Q: There's been a strong surge in commodity prices. Do you think it's a long-term trend?
A: I have never owned much in oils, but I must say I have some oil stocks today. You look at the 81 million barrels a day that we consume, and you know, if the world grows at 2 percent a year, we need 1.6 million more barrels every day. And we haven't really made many discoveries the past 10 years. The North Sea has peaked out, the North Slope in Alaska has peaked out. You have Saudi Arabia running full out, Mexico running full out, and Russia coming back, so there's not a big cushion.
If the economy is good in 2005 and 2006, the world demand for oil is going to go up. But it's the only group where people are assuming prices will be sharply lower next year. Everyone is looking for oil prices to fall 25 percent to 30 percent. Even if they do, these companies are going to earn a lot of money.
Q: What sectors do you like?
A: I have some money in airlines. It's not a big weighting, it's speculative, and it's the ones I think won't go bankrupt.
I also own retailers and restaurants. I don't buy this argument that the American consumer is spent out, and that when the economy gets better, they've shot their wad. Don't underestimate the American consumer. If we're adding 150,000 jobs a month in 2005, 2006, they're going to be buying a whole lot of everything. Americans love to buy stuff. I have a large bet on telecom and tech. A lot of companies are still down 70 percent, 80 percent. If the stock sells for $3 a share and they have lots of cash, they'll be around.
Q: What about banks?
A: I think they're doing brilliantly. But when everything is going great, I'd rather tune in later. It's just the greatest scenario, everything is great, spreads are great, nonperforming loans are low. This is nirvana. They're cheap stocks, good companies. They're stocks to sell. I just like to look at things that are out of favor, and they don't fall into that category.
Q: Ever think of going back to managing a fund?
A: When I left, I said I wanted to spend more time with my wife, my kids, with charities. I work for an inner-city scholarship fund in the archdiocese of Boston. It's a huge thing I spend time on. I've averaged 100 days of vacation every year the past 14 years. People say, "He'll be back. The Lynch fund will be coming." But no. No.
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