   |
|||
Trading Like a Seventh-Graderby Sala Kannan
The golf course has always been fertile ground for business talk, but for an 11-year-old caddy, it changed his life - and set him on the path to become one of the most celebrated legends of Wall Street. And the secrets that this boy picked up on the fairways during the 1950s could also help you build an incredible portfolio of small-cap winners. Who was this club-toting wunderkind? Peter Lynch, of course, the storied fund manager of the Magellan Fund. As a boy, Lynch learned about investing in the 1950s, when he was a caddy at a posh golf club. He constantly heard corporate executives and financial bigwigs talk about stocks during their golf games. Lynch quietly noted down the names of stocks he heard about at the golf course. Then he looked up their prices and found that months later, these stocks were going up. That process led Lynch, decades later, to the development of a stock-picking theory based on companies that "make sense." Because back then - before computers, before the quarter-to-quarter rat race, and before cutthroat global competition - the kinds of executives that Lynch caddied for invested in companies that produced the unglamorous staples of industry and daily life. At age 33, Lynch became one of the youngest fund managers when he took over Magellan. By this time, he had had a stint in the Army and had a degree from the Wharton School of Business - giving him the kind of background that applied both practical and theoretical strategies for finding great companies that "make sense." So for Lynch, to "make sense" meant putting the money of Magellan's investors into businesses that were easy to understand. It meant investing in companies that made everyday products. And the payoffs were huge. If you had put $10,000 into Magellan when Lynch took over in 1977, 13 years later, when he retired from the fund - your $10,000 would have grown into a whopping $288,000. How did Lynch do it? His technique was to keep it simple. For example, he invested in retail stock because he understood the business - everybody needs to shop for clothes, and he observed consumer behavior through his family's shopping sprees. Lynch achieved great success by investing in companies he understood and by staying away from businesses that he could not understand. In fact, even Warren Buffett has often admitted that he stayed away from the tech mania of the late '90s only because he did not understand technology and computers. The simple policy of staying away from what you don't understand can save you a lot of money. And investing in what you do understand can make you a ton if it. Often, Lynch's stock ideas came from everyday life and mundane observations. While running Magellan, Lynch was always open to any idea and ready to investigate or dig deeper, no matter where the investment idea stemmed from. At one point, pantyhose maker, Hanes, was the fund's largest holding, and the investment idea came from Lynch's wife, Carolyn. Carolyn came home one day from grocery shopping with her new find - Hanes pantyhose. She loved the product. And Lynch started investigating. He found that the average woman goes to grocery stores more often than department stores. But the best pantyhose was sold only in department stores. Hanes, on the other hand, sold its hosiery in grocery stores as well. Lynch knew he was on to something. He even went out and bought the products of competitor, Kaiser-Roth. He requested his employees try both products out and give him feedback. "Hanes is better," was the unanimous conclusion. Lynch's painstaking effort to understand Hanes and its product paid off handsomely. The stock experienced hyper-growth and yielded 500% gains for Magellan's portfolio, and eventually got bought out by Sara Lee. How many fund managers actually go the store, buy the product of a company they are researching and even try out its competitors' products? This fundamental research at the grass-roots level is what distinguishes Lynch from other fund managers. The typical mutual fund manager gets his stock picks from piles of annual reports, stock screens flickering on his computer and the mainstream media. He talks to colleagues on Wall Street for investment ideas - the people that read the same annual reports, run the same stock screens and read the same Wall Street Journal articles every day. Lynch, on the other hand, gets his investment inspiration from the mall, the streets, his daughters, his dining table and even from his barbershop. He calls the story of how he found hair salon chain, Supercuts "My Close Shave at Supercuts." After a visit to this hair salon, and, later, some research on the company, Lynch decided he didn't like the haircut, but loved the stock. Lynch rationalizes his love for Supercuts like this: "The theory behind Supercuts is that hair care is a $15-40 billion industry dominated by independent barbers... Barbers are a vanishing breed. Hair grows half an inch a month. This was the perfect opportunity for a well-managed... franchise to come in and capture the market." It was that simple. Hair grows half an inch a month, and there weren't enough people to cut it. Lynch recommended Supercuts for Barron's that year. Regis Corp. eventually bought out the company. What makes Lynch unique is the fact that his investment ideas come from all walks of life. Some of his best picks were introduced to him by his family. Lynch hung out with his three teenage daughters at the mall in order to get stock ideas. On a Christmas shopping trip to the mall more than 13 years ago, Lynch's daughters dragged him to The Body Shop - a skin and hair care products maker and retailer. While the girls delighted in kiwi lip balm, beeswax mascara and honey-oatmeal facemasks, Lynch was uncovering a fabulous investment opportunity. "The Body Shop was one of the most crowded stores in the entire mall," Lynch notes. The Body Shop started in British housewife Anita Roddick's garage and "from its modest beginning... was soon transformed into an international network of franchises devoted to applying fruits and salads to the skin. In spite of two big bobbles in six years, the 5 pence issue had turned into 362 pence," observes Lynch in his excellent book, Beating the Street. Lynch was impressed by the fact that the company reported increased same-store sales in 1991, despite the recession. He also found that The Body Shop had a "price niche" -- its products were costlier than those at discount stores, but cheaper than department store products. Lynch jokes in his book that his daughters often initiate coverage on companies he buys. And their coverage on The Body Shop was profitable, indeed. His strategy is so simple that it suits the individual investor perfectly. In fact, the small-cap investor can make a killing a la Peter Lynch - many of Lynch's picks started out as small caps. Lynch himself has often said that the small scale, individual investor has an advantage over the large mutual funds - individual investors are not governed by the kinds of rules institutions have to follow. This means retail investors can invest in stocks that institutions can't. Also, individuals are not under pressure, like the investment banks, to tout the stocks they have taken public. Lynch was a fan of a certain group of small-scale investors: seventh-grade students at St. Agnes School, Massachusetts. This group of students built a model portfolio of companies whose products they used and understood, like Walt Disney, Gap, Nike and Wal-Mart. The seventh-graders bought what they knew. Which is why they bought Pentech Intl. -- a maker of colored pens. This model portfolio gained 70% from 1990-92, while the S&P 500 gained 26% for the same period. And this buy-what-you-know portfolio beat 99% of all equity mutual funds during that period! A bunch of New England seventh-graders had beaten Wall Street at its own game. And they did it simply by picking companies whose products they came across every day. The seventh-graders' success proves Lynch's point further - buy stocks that make sense to you. Best regards, Sala Kannan Editor's Note: From India and a graduate of the University of Cambridge, Sala Kannan boasts connections with economists and industry insiders worldwide. An expert on global economic trends, she's especially well versed in developing nations, such as India, Brazil, Argentina and China. Kannan Archives.
321gold Inc |
