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peter lynch is making quite the name for himself in the finance world as one of the smartest investors up to date he's got a return of 29.2 while managing the magellan fund which was also named one of the top performing mutual funds in the world so now we will be breaking down peter's lynch's advice from one of his interviews he talks about high stock market prices and what to do with them but before that who exactly is peter lynch so besides being one of the smartest investors he is one of wall street's biggest money managers we now know that he runs the fidelity's magellan fund from 77 to 90.
after 13 years of him behind the wheel it was up an astonishing 2700 percent making it the world's largest mutual fund currently he is still sitting on the board of trustees for the delta group and is also the vice chairman of fidelity management so what does he know so peter lynch explains the situation of the us economy during that time the market was roughly at 4 000.
then it started shooting up around 8 300 by the next couple months for lynch he stated that it was actually healthy to back off a few numbers rather than go for the long shot sometimes he compared this with japan japan's market started with 5000 at a certain point jumping to 15 000 it was standing at a fair price by then however it continued to increase until it reached 40 000.
this resulted in highly inflated real estate people overspending leaving japan to be in a recession for five to six years just because their market was actually too high whenever a market gets too high you're discounting earnings to around seven or ten years out because everything is basically overpriced since world war ii the market has been sold between 10 times earnings and 20 times earnings once you look at the dow jones or the s p fund you add up all the companies and get the earnings you might say they are fairly relative for example mcdonald's earnings have been doing incredibly during the last 30 years or so with that there is a direct relationship the earnings of the s p 500 have been between the range of 10 and 20.
we were almost reaching beyond 20 which is the highest point a p e range should be fairly where there has only been a few times where it has gone beyond the 20 point usually by the time the inflation would have dropped to zero in the 1960s that's when inflation was zero and indeed the s p 500 went past 20.
currently we have a low inflation rate so when you usually subtract the inflation from 20 you get the p of the market and the ratio has been pretty good so far in the early 80s the inflation was at 12 or with an 8 or 9 p in the market according to peter he never thought he'd wish for the market to not go up it didn't seem to make sense before but it's clearer now if ever the market went up to 16 000 tomorrow there would be earnings behind companies in addition stock market prices ought to be relative to earnings earnings performance and earnings potential so was a decline in the market actually reasonable especially if it was overvalued at the time apparently letting it off when it's at a high point can be beneficial lynch believes it would be fairly priced in that case maybe for big companies or even small enterprises there have been around 3 000 companies going public in the last 4 years several companies have gone down dramatically so that's a sort of feasible for average people in the stock shop some people are aware of certain public companies some brands seem very attractive but no one exactly follows them lynch advises that you go for companies with union companies who are in trouble or even the underrated companies you have to look at 20 to pinpoint a good stock it's not like the mall and instantly finding what you're looking for so once you think a stock seems worthy you still have to go through a series of steps to determine its true value this is like how people are careful when they buy products you buy a toaster or a tv or even pick out what to eat you still do some research to see if you are spending your money on what is worth it but a lot of times especially small investors tend to buy stocks the first time they hear about it you hear the next guy boasts about his recent hot stock purchase and they blow five thousand dollars the next day you know how it gets very cold in a winner and you get memories of it so somehow you feel when winner is coming next well it can be applied to the stock market so whatever happened to other countries should be a reminder or at least a warning that something is going to happen or better yet you get how profits can actually go down in addition to lynch's interview he was asked if other countries can affect the us or market as a whole he says it probably does so how does this happen those asian countries have been growing at a double-digit pace and suddenly they go under leverage due to bank problems or they're over financed in fact people start talking about how china could be going into a recession and this became a wake-up call that there might be something going on although it did not have much of a big impact in the u.s economy itself when mexico went down the situation would have been a bigger deal versus the economy of thailand or the philippines this is because they are more geographically linked and are a big consumer of the us market naturally latin america's economy greatly affects the united states at some point one thing you try to do though is out of all the public companies that you can see there's this one company that you like let's say it's because of their fundamentals their earnings are doing well there's little to no competition then all of a sudden their stocks fall from 40 to 30 because of the decline you could have seen this as an opportunity to buy it sure during the decline some companies you might think have been overpriced from 60 to 50 which seems like a good deal so you probably would go for the companies that you initially liked anyway you don't go for the ones who were highly priced and got cut to a fairly priced rate it's best to just buy the ones who were fairly priced from the beginning so was peter lynch going to go on a buying spree during the market decline no as a matter of fact he would have been researching harder looking for companies that are the same story despite a decline or even a recession we have companies that still stand their ground without much changes those are the kind of companies that peter would be aiming to buy let's say we have a company that you think would be earning big in the future and if it's already discounted and selling huge multiples no doubt this will work but when it all goes and stays only even so the question you should be asking is if i'm right how much am i going to make if i'm wrong how much am i going to lose we call that risk-reward ratio in a stock shop you should be aiming to be doubling or even tripling your money if you bet on the right ones if you're wrong let's hope you lose only around 30 to 40 percent and that right there is a favorable ratio you need to have an edge or at least be aware of a company's edge for example a cement company goes from being underrated to a bit average to fairly good at this trajectory you know the stocks are going to go up that's the industry you know and can trust what if you also worked in a restaurant over the past couple years then we assume you would have known taco bell you would have known pizza hut you would have known and seen chili's you would have been well aware that these companies are doing well in that certain industry so you go ahead buy those stocks rather than going for biotech companies which you know nothing about this works to your advantage since you would be early in the ball game so take the chance to buy from companies that you know instead of going out and buying something unfamiliar people have this tendency to always buy and buy but all you actually need is a few good stocks all you need is data what if you're looking at companies that are doing poorly so naturally you buy the one that has a three million dollar in cash instead of the one that is on the road to bankruptcy a lot of companies are selling two to three dollars a share but they might be losing 10 million you just have to be smart enough to look up the balance sheet and see whether the company you would want to buy is headed the right direction at the same time peter lynch advises people to spend both on stocks and mutual funds you could spend on mutual funds occasionally while also looking to buy stocks that you think would make a difference in your life or at least in your portfolio and namely an industry that you know something about local companies also work well since you could experience them firsthand peter shares an anecdote where he stayed at a motel and got a few comments from his competitors eventually he wounded up buying their stocks in a way there's more to just watching data to be able to get information don't throw it away peter also shared even if i hadn't made much money i'd like to see people do a better job obviously he wants to see a lot of investors follow in his footsteps maybe even outdoing the success he's achieved he likes sharing what he can so he can help in improving the investing habits of america in a way he also said that if you're not able to are ready to invest properly don't do it so what advice does he have for the future market of our investors again it's no guarantee he says that the next 6 000 or 14 000 or even 20 000 points could be up or down it's pretty futile to try and guess it what you could rely on is corporate profits are going to be up every few years new companies will come along so you got to keep your eyes peeled so lynch keeps his optimism about the future of the american economy for earnings potential most companies would be doing well in the long run but don't forget we've had nine recessions since world war ii it's a given that we would have more in the future as well and guess what no one will tell you when this is gonna happen all of a sudden you might notice orders slowing down prices are getting more competitive earnings are down usually you just need to find those warnings they say we are gonna have a recession on and on but it still hasn't happened yet so let's not get too carried away with worrying now let's wrap up the main points from lynch's interview one of the first things that they discuss in the interview is the market p e ratio once you see the p e ratio tip over 20 that's when you need to be on high alert now that is the market of the united states right now it is above the 20 mark and what does that tell you prices are high so how do we invest in this kind of market condition let's recall lynch's interview first buy good quality businesses that are strong in the market competition these are the ones that are going to survive a crash that could happen second check if they have strong and stable balance sheets and it's also best to make sure they are still holding cash in case of emergency third be knowledgeable about the company you own you wouldn't want to buy a local business knowing absolutely nothing about it again what you know will grow and of course good times don't last forever be always prepared for a possible market crash like what peter mentioned the market could go up but it can also come down so keep yourself recharged financially and of course emotionally we know it's not easy but that's a good thing because most people wouldn't be in either so if you are you win
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