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One thing you try to do is say, of all these public companies that exist, this is a company that I really like. The fundamentals are fantastic, their earnings are doing well, and their competitors are underperforming . I think this company is doing excellently. And suddenly, the stock could have gone from 40 to 30 because of this drop.
That would make you say, "Wow, this is an opportunity to buy it." So, you try to say that some companies might have been overvalued at 60, and all they did was drop to 50, and you say, "What a big deal." Therefore, you try to find companies that you liked anyway. Now you like them, and they've also been cut down .
That's what you would do. Not a small change from overpriced to fairly priced. Someone who had a fair price at the start of this exercise and then got an offer, you know, a really good one. Hello everyone, welcome back to the channel. In this video, we're going to talk about some investment lessons we can learn from Peter Lynch to apply to our investments in 2021.
So, let's watch an old interview Peter Lynch did with Charlie Rose. And I must apologize, some of the cuts in this interview will be quite abrupt. It's because I don't understand, Charlie Rose just keeps interrupting Peter all the time in this interview. So, I apologize. I tried my best to get to the heart of the argument, because I think the whole interview lasts about 25 minutes.
So , I've tried to cut it down to leave the best parts. That said, let's get right into it. I'm glad to be here. Explain to me what's happening. Well, we had a great run. In other words , the market was at 4,000 just, you know, two and a half years ago. And it rose to 8,300 in August. And, you know, like any big surge, sometimes it recedes.
In other words, it's healthy. Is it really? Because everything is overrated. Yes, and that doesn't help at all. Since World War II, the market has sold for 10 to 20 times the profits. If you look at the Dow Jones or the S &P 500, if you add up all the companies and take the profits, you see that there is a relationship.
And that is true. McDonald's earnings have been fantastic over the past 30 years, and the stock has been fantastic. There is a direct relationship. So, the S&P 500's gains have been in this 10 to 20 range. We were about to break above 20, which is the upper end of the price-earnings range. There wasn't much room left in the So, is a ratio of 20 the maximum limit it should reach?
Correct. It has only been above 20 a few times in history, and that is when inflation is usually close to zero. And so, this clip sets the stage because what Peter Lynch describes here is really what we see today. He talks about how the market's price-to-earnings ratio generally sits between 10 and 20, with 20 really being that upper limit.
Well, these days we've discovered what the ultra-upper limit of that number looks like, and it appears to be close to 30. Now, that's a little scary because what we're currently seeing is a price-to-earnings ratio for the market of 35. And it's only been above 30 three times in history: 1929, 1999, and right now.
So there's no doubt the market is certainly hot, just as it was when Peter Lynch gave this interview in 1997, but the question we need to ask ourselves is: how do we invest in this environment? Yesterday's drop, in a sense, alleviated some of this overvaluation. The market was even overvalued where it was, and by freeing that up, we returned to what was reasonable.
Well, yes, I would say they are fairly priced. Perhaps for the larger companies they are fine now. There might be some small businesses. We've had 3,000 companies go public in the last four years. That 's two per business day. Some of those companies have fallen drastically, and that's an area of research that average people can find in the market.
Some people know a lot about these 10,000 public companies. Many of them are very attractive. Nobody follows them. There are a lot of people following IBM. Many people follow companies that no one else followed. I like to see companies with unions, companies in trouble, or companies that nobody looks at.
Hotels that had good beds and well, yes, you have to look at many of them. What stockings did my wife wear? I don't know the story. Okay, you have Pier 1 Imports, my wife found that one too, but you have to look at 20 to find one. It's simply, you know, go to the mall and find the action. In other words , you have to say, oh my God, this sounds good.
Then you have to follow some steps. You need to follow an organized method. Now, we'll get to that method in a second, but in this clip, Peter inadvertently describes exactly how we should be approaching our investments right now. Because today , although the market is very high, we are in an environment where, in reality, many companies are falling.
And what we see is that an index like the S&P 500 is literally propped up by five to ten giant high- performing companies. Now, what Peter tells us in this clip is that to be a great investor even when the market is overvalued, you have to stop looking only at those giant companies. Everyone follows these big companies.
Everyone is investing in them, and the prices of these large companies are sky-high. So we should broaden our horizons and look perhaps at companies that come after the fiftieth largest stock in the S&P 500 or maybe beyond the twentieth largest in the ASX 200, because that's where you're most likely to find value.
And then, the other secret is that, of course, you have to keep looking at many companies. The best investors are the ones who move the most stones, right? As Peter Lynch said in this interview, you have to look at 20 to find one. Okay, with that said, let's look at the actual steps we should all take to move forward and make an investment in this type of environment.
Then you have to follow some steps. You need to follow an organized method. People are careful when buying a toaster. Careful? They are careful when they buy one. They are. They do some research. But they don't do it with stocks. They call their broker or see someone at lunch and say, " Hey, I've got this hot stock." And you run out and spend $5,000 .
Small investors. Or worse, they put an option in International Data , what? They don't even own International Data. They have a 90-day bet. But Bill said it was good and that they would make a lot of money. Correct. Correct. And it's like a casino . Yes. So, it's like a casino. You get the same results, except there's more paperwork.
Very good. So, this morning you get up and go and look at those companies that fit that... that you know something about. You need to have an advantage. I mean, let's say the cement industry goes from bad to mediocre and then to pretty good. The stocks are going to go up. You're going to make money.
That's the industry you know . What happens if you know the publishing industry? You...Some people have...You have an advantage. You work. I mean, what if you've worked in the restaurant industry for the last 30 years ? You would have seen Taco Bell. You would have seen Sbarro. You would have seen Pizza Hut.
You would have seen Chili's. You would have seen that these companies were doing very well. You should have bought those instead of trying to buy biotech stocks you know nothing about . I mean, I don't know anything about local area networks. Many people are buying Cisco. They're buying the equipment saying, "We're going to connect all these peripherals and assemble the servers." But...but that's not a bad purchase because they own a large percentage of their market.
Yes, but that was... They say only a few people had them. I said, " My God, if it works for us, others will try it, then universities will try it, high schools will try it, then they'll go abroad." They knew they were in an early stage of the game. Correct. And they should have been buying that company instead of going out to buy something they know nothing about, some oil drilling company.
I mean , people have this tendency to always buy something they don't... All you need is a few, Charlie, all you need is a few good deeds. Yes, but that's your song. This has been your song for a long time. Only buy what you know. No, but people wake up in the morning and say there are 5,000 companies out there, which one should they buy?
The average person should be able to follow four or five companies. They could give a lecture about them. Companies understand. And this forces you... This tool tells you: " Write the story." But you keep saying this, this... So, that makes sense. You obviously have to start by doing some research. You know, he says, " People do a lot of research when they go to buy a toaster." Why don't people do much research when they're going to buy a stock?
You know, don't treat the stock market like a casino. And then, when you actually sit down to learn about some companies, look at the companies that are really relevant to you. Warren Buffett would use the phrase stay within your circle of competence. Peter Lynch's example here is, you know, if you're someone who works in the restaurant industry, look at Pizza Hut, look at Taco Bell.
These are companies that you probably already understand at a fairly high level. And don't mess with those biotechnology companies that nobody understands. So, once you find those companies that resonate with you, then you go in and do that research. And as Peter Lynch says , you only need four to five good deeds in a decade.
Warren Buffett would say you need even less than that. But you need to know those companies well enough to give a lecture about their business. So that's really the first step. The first step is to stay within your circle of competence. Second step, go in and understand those businesses thoroughly. And after that, what happens next?
Okay, let 's listen. One thing you try to do is say, " Of all these public companies out there, this is one I really like. The fundamentals are fantastic. Their earnings are doing well. Their competitors are doing poorly. I think this company is doing excellently." And suddenly, the stock could have gone from 40 to 30 because of this drop.
That's what I'd say: "Wow, here's an opportunity to buy it." So you try to look at some companies that might have been overvalued at 60 and all they did was drop to 50 and say, "Big deal." So you try to find companies that you liked anyway. Right now, you like them. And now they've had a price cut. That's what you would do.
Not a stock that went from overvalued to fair price. Something that was fairly priced at the start of this exercise and then , you know, had a five-for- four offer. If you had been managing the Magellan Fund this morning, you would have been buying like crazy. I would have been investigating like crazy.
I would have been saying, " Which companies have the same story? Is something really going on?" This is a non-event for them. They're still working well. Even if we have a recession, it has nothing to do with them. And that's the kind of company I was trying to buy. But let's say, if a company, just think of it this way, you say to yourself, "I believe this company is going to make something in the future." If you're already discounting that, if it's selling at a huge multiple, you say, "That's it , it has to work." And then it will just stay the same.
So you have to ask yourself, "If I'm right, how much am I going to earn?" If I'm wrong, how much will I lose? That's the risk-benefit relationship. When buying stocks, we talk about how, if I'm right, I expect to double or triple my money. If I'm wrong, I might lose 30 or 40%. That's a favorable relationship.
We say: if I'm right, the stock won't go up. He's already discounting fantastic things. If fantastic elements are already being discounted in the action, I don't want it. OK. So the first step is to find a company where you have an advantage. The second step is to really understand the business, to understand the finances and the fundamentals.
But what Peter Lynch mentions in this environment, where basically everything is overvalued, is that what you want to do is try to find companies that have a fair value, even in this environment of extreme overvaluation. Because as investors, what we do is buy undervalued stocks, right? We always buy at a discount to the intrinsic value, and that's how we know we'll make money in the long run.
Now, if you find a company that is truly excellent, but also very expensive in this environment , and then there is some kind of market drop of 10 or 15%, and that brings the stock back to its fair value. Well, remember that it's still like paying the full retail price for that stock. So, what we're looking for are great businesses that, in this overvalued environment, have a fair value.
So, if something suddenly happens in the market and causes a 10% or 15% drop, that business suddenly goes from having a fair value to being undervalued. Those are the situations we're looking for. Imagine this: the full retail price of the new Xbox One X console is, I believe, 750 Australian dollars.
If you went to EB Games, for example, and they were selling that Xbox for a thousand dollars and now it dropped to 750, you wouldn't be excited about that offer because it simply went back to its normal price. But if that same store offered, say, that it started at $750 retail and then dropped to $500 , well, obviously that's a much better deal.
It's exactly the same with businesses in the stock market. And quickly, another thing to note from what Peter Lynch said in this short clip was when he said that if a stock is trading at a huge multiple, it basically has to work, right? And if it works, then you're barely breaking even. Now, even today we see that some companies, although they are large companies, are trading at P/E ratios in the hundreds, if not literally in the thousands.
Like some companies, for example Tesla, I believe it has a P/E ratio of 1,300. This means that the price investors are paying today already anticipates continuous and flawless growth for years and years and years to come. That's what the stock price tells us. Now, if you invest in a company like this at these prices, there's very little room to gain and a lot of room to lose, because investors already expect years and years of perfection, right?
Of absolutely perfect execution. As Peter Lynch says, you have to consider if I'm right, how much will I gain, and if I'm wrong, how much will I lose? And those are a couple of very important questions to ask yourself before buying a stock. And that's where you go back to your discounted cash flow analysis and look at the growth rates to determine what that risk-relationship is for the company you're analyzing.
What do you tell people today about the short-term future of the market? What's your feeling? I need to buy businesses that grow. Take out a coin and throw it. I have no idea what the next thousand points will do . The next six thousand points will be upwards. The next fourteen thousand points will be upwards.
The next twenty thousand points will be upwards. But you don't know what the next thousand will do. They could go down, they could go up, they could... Nobody knows. And it's useless trying to guess. Corporate profits will be higher in ten years, they will be much higher in twenty years. That's what you can rely on.
The third key step that Peter Lynch highlights in this clip is to always focus on the long term. Don't worry about what the market will do next week, next month, or even next year. What you should really focus on is what this company will look like in 5 years, in 10 years. Always focus on the long term, because if you can do that, then short-term market fluctuations don't really matter, and you simply don't stress about them at all.
In fact, when prices go down, you get excited. You're not scared. As Peter Lynch says, you know, corporate profits will be much higher in 10 years. They'll be much older in 20 years, and that's what you have to rely on. So, we are confident that yes, companies will continually improve. Maybe not for the next year or two.
Perhaps there is something like what we saw with the lockdown, where the business is affected for a year or two, but even so, we don't mind because we look for situations where we ask ourselves, "What will happen in 5 years? What will happen in 10 years?" And if that situation is favorable, that's when we invest.
What about all the criticism of derivatives and the impact they have had? That's a little complicated for me. All I know is, I mean, I don't know about derivatives for you. That's way above my level. I have never bought an option in my life. Never buy a "Times" from your side when you own a stock. You know, I don't know about putting, you know, a 3% down payment and buying a futures contract and a "scrap" and a "straddle".
That's way above my level. I can't, I can't deal with that. Alright . Let someone else handle that. Very good. So, you're optimistic about the future of the US economy. The profit potential for most well-managed companies will be good. But people need to understand that we've had nine recessions since World War II.
We will have other recessions. But we're not in one right now. But we could have one in the future . Don't worry about that. We'll have one. It will happen at some point, and nobody will tell you when it will. It's a good thing, but won't the fundamentals tell you that ? No, you'll find out after the fact.
Suddenly you'll notice orders slowing down, prices becoming more competitive, and then profits dropping. I mean, you usually find out after the fact. Nobody is declaring it; everyone has been saying that we're going to have a recession for 5 years. It simply has n't happened. It's nice to see you. I hope you come back whenever you want, Peter.
You know, I really like this latest Peter Lynch clip. It's simply a lesson that you don't have to be too sophisticated, right? You don't have to stray into things you don't understand. Like many stock market investors, they are obsessed with options. Peter Lynch is the first to raise his hand and say, "Look, I love investing in companies." I have no idea what happens when it comes to options.
I have never bought an option in my life. "So, you know, step one: find the businesses that, you know, you understand." Step two, make sure you are looking for fairly valued businesses that may be undervalued. Step three, focus on the long term. Find solid businesses with low debt, high cash flow, and stay focused on that, because that's the winning formula, you know?
We are going to see recessions in the future. We have seen recessions in the past. It could happen tomorrow. It could happen next week. It could happen in a year or in 5 years. But the main thing is that strong companies with solid cash flows that you understand, and that you are going to maintain for a long period, are the ones that will survive.
And these are the ones we should be ultra-focused on in any stock market environment. Anyway, guys, I hope you enjoyed this video. I always enjoy listening to what Peter Lynch has to say, even in these very old interviews. For example, this one is from 1997. And yet, because the market was high then and is high now, everything he says is almost directly applicable to what we do today with our investments.
And I love it. I love it when we can draw those kinds of parallels. It's like poetry. But anyway, guys, I hope you enjoyed the video. Leave a "like" if you liked it. Subscribe to the channel if you haven't already . And be sure to check out the profitable links in the description below if you want to learn how I make my investments.
If you want to learn about many key points of Peter Lynch's strategy in much more detail and step by step, feel free to check out the introduction to stock analysis. But that's all for today, guys. Thank you so much for watching, and I'll see you all in the next video.
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