Stop listening to stock market experts

Investing is an art and people who’ve been trained to rigidly quantify everything have a big disadvantage, writes Peter Lynch

Peter Lynch is one of the foremost fund managers that Wall Street has ever seen. Lynch was made the director of the little known Fidelity Magellan Fund in 1977 after having been the director of research at Fidelity Investments from 1974. In the ensuing 13 years, the investments in the Magellan Fund rose from a measly $20 million to $14 billion.

In 11 of the 13 years Lynch was at the helm, his fund gave more returns than the S&P 500 Index. Lynch retired from active fund management in 1990 after having delivered an astonishing return of 29% per annum in the 13 years he was in charge
After retirement, Lynch passed on his investment wisdom through books. In the book, “One Up on the Wall Street” written along with John Rothchild, the first piece of advice given is to “avoid experts”.

“But the rule number one, in my book, is: Stop listening to professionals! Twenty years in this business convinces me that any normal person using the customary three per cent of the brain can pick stocks just as well, if not better, than the average Wall Street expert”, the authors write.

The idea for investors trying to invest on their own should be to outperform the experts. As the authors write: “Moreover, when you pick up your own stocks, you ought to outperform the experts. Otherwise, why bother?” If you cannot outperform the markets, then simply invest in mutual funds. “The mutual fund is a wonderful invention for people who have neither the time nor the inclination to test their wits against the stock market, as well as for people with small amount of money to invest who seek diversification,” the authors write.

If the idea is to beat the expert, by going it alone, of course, it cannot be easy and calls for a lot of discipline. As the authors write, “that means ignoring the hot tips, the recommendations from brokerage houses, and the latest ‘can’t miss’ suggestion from your favourite newsletter - in favour of your own research. It means ignoring the stocks that you hear Peter Lynch, or some similar authority, is buying”.

Now all this sounds terribly difficult to execute. What does it take for an individual investor to do this?  Most people are of the view that an education in business, math and accounting is most necessary for those who want to invest well.

Peter Lynch does not agree. “In college except for obligatory courses, I avoided science, math, and accounting - all normal preparation for business…. Investing in stocks is an art, not a science, and people who’ve been trained to rigidly quantify everything have a big disadvantage. If stock picking could be quantified, you could rent time on the nearest Cray computer and make a fortune. But it doesn’t work that way. All the math you need in the stock market (Chrysler’s got $1 billion in cash, $500 million in long term debt, etc.) you get in the fourth grade.”

So what is it that Lynch feels you need to invest successfully in the stock market?

“Logic is the subject that’s helped me the most in picking stocks, if only because it taught me to identify the peculiar illogic of Wall Street. Actually Wall Street thinks just as the Greeks did. The early Greeks used to sit around for days and debate how many teeth a horse has. They thought they could figure it out by just sitting there, instead of checking the horse. A lot of investors sit around and debate, whether a stock is going up, as if the financial muse will give them the answer, instead of checking the company.”

And because of this illogic, most Wall Street Investors end up being victims of what Lynch calls the ‘Street lag’. “Under the current system, a stock isn’t truly attractive until a number of large institutions have recognised its suitability and an equal number of respected Wall Street analysts (the researchers who track the various industries and companies) have put it on the recommended list. With so many people waiting for others to make the first move, it’s amazing that anything gets bought”.

This disadvantage an individual investor does not have. As the authors write, “ Most important, you can find terrific opportunities in the neighborhood or at the work place, months or even years before the news has reached the analysts, and fund managers they advise”. So the first thing is to keep your eyes or years open and more than that ask some basic questions. “By asking some basic questions about companies, you can learn which are likely to grow and prosper, and which are unlikely to grow and prosper, and which are entirely mysterious. You can never be certain what will happen, but each new occurrence - a jump in earnings, the sale of an unprofitable subsidiary, the expansion into new markets - is like turning another card. As long as the cards suggest favourable odds of success, you stay in the hand.” 

Having said that it is very important that the individual figure out whether he has the qualities it takes to make for a successful investor. “This is the most important question of all. It seems to me the list of qualities ought to include 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 mistakes, and the ability to ignore individual panic”, the authors write.

Other than this it is also important to have the ability to make decisions without ‘compete or perfect information’. “Things are never clear on Wall Street, or when they are, then it is too late to profit from them. The scientific mind that needs to know all the data will be thwarted here.”

And the most crucial thing is the ability to what the authors call “human nature and your gut feelings”.
 
As they write, “It is the rare investor who doesn’t secretly harbour the conviction that he or she has a knack for divining stock prices or gold prices or interest rates. In spite of the fact that most of us have been proven wrong again and again.

It’s uncanny how often people feel most strongly that stocks are going to go up or the economy is going to improve just when the opposite occurs.”

Hence there is no point in trying to predict where the market is headed to. As the authors write “When it comes to predicting the market, the important skill here is not listening, it’s snoring.

The trick is not to learn to trust your gut feelings, but rather to discipline yourself to ignore them. Stand by your stocks as long as the fundamental story of the company hasn’t changed.”