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peter lynch was one of the greatest investors of all time as a manager of the magellan fund at fidelity investments from 1997 to 1990 lynch averaged a 29 annual return consistently more than doubling the s p 500 making it the best performing mutual fund in the world in this 1994 recording lynch shares some of his investment wisdom that has helped make him and his clients millions in this specific excerpt lynch shares advice on how to deal with a falling stock at the end of this clip we'll elaborate on lynch's points and demonstrate examples of how you can put his advice into practice within your own investment portfolio so sit back and enjoy there's a lot of times people buy on the basis the stock has gone down this much you know how much further can you go down i remember when polaroid went from 130 to 100 people said here's this great company great record if it ever gets below 100 you know just buy every share you know and it did get below 100 a lot of people bought on that basis saying look it's kind of 135 to 100 it's not 95 what a buy within a year it was 18.
and this is coming with no debt i mean as a company it was just so overpriced it went down uh i did the same thing in my uh i think my first or second year fidelity kaiser industries had gone from 26 this year to 16. i said how much lower can it go it's 16. so i think we bought one of the biggest blocks ever in the new york on the american stock exchange of kaiser industries at 14.
i said you know it's gone from 26 to 16 how much we're going to go well at 10 i called my mother and said mom you got to uh look at this kaiser industries i mean how much lower can it go it's gone from 26 to 10. well i went to six it went to five it went to four and went to three and uh now i unfortunately haven't rapidly i would probably be still caddying or being working at the stopping shop but i it happened fast i was able to this was compressed that uh and at three i figured out you know there's something very wrong here because kaiser industries owns 40 kaiser steel they own 40 percent of kai's aluminum they own 32 percent of kaiser cement they own kaiser broadcast they own kaiser santa gravel kaiser engineers they own jeep they own business after business and they had no debt now i learned this very early this might be a breakthrough for so many people it's very hard to go bankrupt if you don't have any debt it's tricky some people approach that it's a it's a real achievement but they had no debt and the whole company at three was selling at about 75 million that point it was equal to buying one boeing 747 i said there's something wrong with this company selling for 75 million i was a little premature at 16 but uh i said everything's fine and eventually this work out and they what they did is they gave away all their shares to their shareholders they passed out shares and kaiser's men they passed out chairs and cars aluminum they passed out their public shares and kaiser steel they sold all the other businesses and you get about fifty dollars a share and but if you didn't understand the company if you're just buying on the fact the stock had come from 26 to 16 and then it got to 10 what would you do when went to nine what would you do when went to eight what would you do when went to seven this is the problem that people have is they sell stocks because they didn't know why they bought it then it went down and they don't know what to do now do you flip a coin do you walk around the block you know what do you do psychiatrists haven't worked so far i've never seen them running in the side the the psychological psychiatry fund i've never seen list this for the uh with the sec to make it through as a mutual fund so i they haven't seemed to help i've tried prayer that hasn't worked the uh the uh so if you don't understand the company of this problem when they go down uh eventually they always come back uh this one is uh this one doesn't work either people think rca just about get back to its 1929 high when general electric took it over a lot of double knits never came back remember those beauties floppy disks western union uh the list goes on and on uh people saying it'll come back well it doesn't have to come back uh here's another one here all the time it's three dollars how much can i lose i've had people call me up saying i'm thinking of buying a stock at three how much can i lose well again you may need a piece of paper for this but if you put uh if you and if you put twenty thousand dollars in a stock at 50 or your neighbor put 20 000 at full at 50 into the stock and you put twenty thousand dollars into three and it goes to zero you lose exactly the same amount of money everything and people say it's three how much can i lose well if you put a million dollars on it you can lose a million dollars just the fact that this is the only this may be a reason to research a stock the fact that stock is three down from 100 doesn't mean you should uh buy it and in fact short sellers people that really make money in stocks they don't show at walmart they don't share home depot they're not sure the great companies johnson johnson they short stocks down from 80 to 70.
they'd like to short it at 16 or 22 but they they figured out at seven this company is going to go to zero they just haven't blown taps on this thing yet it's going to zero and they're selling short seven they're selling a short at six at five at four at three and two at one and a quarter and you know sell something short you need a buyer somebody has to buy the damn thing and you wanna who's buying this thing it's these people saying it's three how much lower can it go like a true master of his craft peter lynch does an incredible job of conveying his investment knowledge in such a concise and entertaining way we'll now elaborate on three of the key points that lynch discussed and how we can apply and incorporate that knowledge within our own investing habits the first key point is simply buy what you know and also conversely if you don't know don't buy now at first glance this advice might seem so obvious and simple that it doesn't really add much insight however it's actually a surprisingly common trap for investors to fall into especially new investors who may not have much investment experience by understanding what you own you have a better sense of the value of the company and the potential upside and downside in different scenarios it's only then that you can make a rational evaluation of the potential risks involved with an investment this concept is also referred to by warren buffett as investing in your circle of competence your circle of competence being the group or subsection of companies that you know quite well and fully understand well it can be beneficial to increase your circle of competence over time investing outside of that circle of competence can often lead to investment mistakes because you simply don't understand what you're buying peter lynch is also an advocate of using your own local knowledge and personal experience which can sometimes help give you an edge as an individual investor i'll give you a couple examples from my investing experience one stock in business that i know fairly well is kroger the largest pure grocery store in the united states i've been shopping at one of their subsidiaries harris theatre for most of my life so i've got a pretty good sense of their core business model as well as the preferences of their average consumer flashback to 2017 though and amazon has just announced their purchase of whole foods many investors ended up dumping kroger's stock as the stock price dropped almost 30 percent in just two days the rationale behind this was that amazon with now whole foods was likely to take more market share as well as compressed margins for kroger however based on my own consumer habits i wasn't planning to now jump over to whole foods just because amazon bought them even after a first wave of price cuts at whole foods prices were still generally cheaper at harris teeter so in my view this was an overreaction in the stock price and i ended up picking up a fairly large position in kroger which remains one of my largest stock positions today however if i didn't understand kroger and their customers i too would probably be quite concerned with amazon entering into the field with whole foods now i would be remiss to give you only a positive example so i'll give you an example of a big mistake i made much earlier into my investment career so this goes all the way back to 2013 this time deals with the stock of apple now keep in mind this is when i was just first starting out investing so i really didn't have a great sense of business fundamentals and stock valuation about a year prior in 2012 i bought apple stock simply because i just genuinely liked the products i had had several ipods in the past and was now very enamored with my new ipad but in 2013 apple saw one of its first declines in iphone sales revenue and from september 2012 to spring 2013 the stock price of apple dropped roughly 40 percent now in that winter i remember exactly where i was in the undergraduate library as i was planning to sell my apple stock at that point the shares were already down roughly 25 off of all-time highs and i was concerned that i might lose more if i continue to hold the stock this is ironic because in that same memory i vividly remember seeing and looking around me in the undergraduate library all the students had not only iphones on the table but also had and were using their mac laptops so given that i didn't really put two and two together in terms of the incisionable demand for their products and also wasn't aware of the fundamental valuations and at the time apple was trading at a price to earnings ratio of 10 which is an incredible value for the potential growth prospects that apple had at the time despite all that i ended up selling my shares in apple split adjusted at around 65 now you can do the math but those shares today would be worth nearly five times more had i just held them for the long term so that gets to a good lesson learned is that if you don't understand the stock you're buying or whatever investment you are buying and the price falls you won't have any metric to evaluate whether the price decline is justified or not this could cause you to sell a stock prematurely to cut losses when in reality market volatility simply causes stock to become undervalued in the short term on the other hand you can also end up continuing to hold a stock that has fundamental issues you may not be aware of overall if you stick with investing with businesses you understand and especially those you have local or specialized knowledge in you will be much less likely to get into trouble and lose money investing the second key point lynch discussed is the myth that a stock will come back well over the long run an index like the s p 500 has historically gone up that isn't a guarantee that all the individual stock components of the index will go up as well many stocks do but some businesses eventually face challenges and never end up recovering going back to our first point you need to understand the fundamentals of the business if you don't when the stock falls you're instead only really hoping that the stock will come back and unfortunately in the long term hope is not an effective strategy so when the price of a stock declines whether this is a stock you own or stock you are watching and potentially might consider owning in the future you should ask yourself some questions is the decline in the stock price justified in relation to the business fundamentals going back to my examples with kroger and apple it's possible that price declines may be short term in nature and potentially over reactions to what would otherwise be stable or improving business performance however for some richly valued stocks trading at high multiples to business fundamentals like earnings cash flow or sales if investors are paying too high a price for an excessively valued stock there's no fundamental reason for the stock to come back to a price it was never justified trading at to begin with this is a risk in investing in some very high valued growth stocks which could potentially see a permanent reduction in valuation multiples the underlying business may still be fine and growing quite quickly but the stock was simply trading too high similar to the polaroid example that lynch provided another question to ask yourself is are you evaluating the business based solely on past performance while many businesses are relatively stable and past trends may be similar to future results looking only at the past can get you into trouble if you miss changing industry trends that will impact the business materially in the future just look at most retail stores with the exception of some big box and discount retailers many of them have not and will not likely recover to their past peaks in fact many of them may cease to exist entirely when looking into a potential company to invest or evaluating a stock price decline i will often check for potential red flags which could signal a deterioration in the business performance going forward overall don't jump into his stock solely because of a price decline under the assumption that it'll go back up to its previous price level you have to understand the underlying business fundamentals to make a rational assessment on whether or not it's an attractive investment opportunity at the now lower price and finally the third key point that lynch discussed is a low share price does not mean low risk and on another note a low share price doesn't necessarily mean that a stock is cheap either a stock can have a low share price but also be relatively expensive compared to the actual business fundamentals per share conversely you can also have some stocks which may appear relatively expensive based on their share price like alphabet or autozone with share prices over a thousand dollars each which could actually be cheap by some fundamental metrics like earnings or growth understand that share price alone doesn't tell you any information in relationship to value and as lynch discussed you don't have any less downside investing in a stock with a low share price one thousand times zero is the same as one times zero and i'll give you a hint they're both zero a recent example of this might be taking a look at the stock of jcpenney now investors of the past seen a cheap share price of five dollars per share might be willing to bet on a turnaround of the struggling retailer applying anchoring bias to the previous all-time high back in 2007 of 85 dollars per share the stock was already trading down 84 how much lower could it go well the shares recently traded in may of 2020 for about 25 cents per share or a loss of 95 percent from that 5 share price if anything seen a particularly low share price is likely a warning sign to look into the business further and many times these stocks are better off avoided altogether so those were just three key pieces of wisdom from peter lynch and there's so much more out there but hopefully that helps give you a little more perspective on the thought process and what you should do to handle dealing with the falling stock price if you like more content like this analyzing videos from great investors let me know by leaving a like on this video and if you're new here consider subscribing to get access to more content like this in the future until next time thank you so much for watching my name's michael and i will see you in the next video
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