Peter Lynch ran Fidelity’s Magellan Fund from 1977 to 1990 and compounded money at 29.2 per cent a year while doing it. In 1994 he stood in front of the National Press Club in Washington and explained what he had learned, and what an ordinary investor should do about it. This article draws out the Peter Lynch investing principles from that speech and finds, not surprisingly, that thirty years on there is still a great deal to learn from him.
If You Can’t Explain It to a 10-Year-Old, Don’t Own It: The Wit and Wisdom of Peter Lynch
A Speech That Refuses to Age
Peter Lynch retired from Fidelity’s Magellan Fund in 1990, at forty-six, having grown it from a small regional fund into the largest mutual fund in the world. The headline number is the one everyone remembers: 29.2 per cent a year, on average, for thirteen years. Four years later he gave a talk at the National Press Club in Washington. He told a few jokes at his own expense, and then said he was ready for questions. The talk was aimed squarely at the ordinary investor, and its subject was what such a person should actually do.
I have listened to that speech several times now, most recently while preparing an annotated YouTube version for the Sweat Your Assets channel. What strikes me is not that it holds up.
Plenty of investment talks from the 1990s hold up, in the sense that the advice was sound and remains sound. What strikes me is that the examples have got better with age, because we now know how the stories ended. Lynch talked about Coca-Cola and Bethlehem Steel, Polaroid and Kaiser Industries, Walmart and Microsoft, and about a doughnut chain he could explain to a child. Three decades on, every one of those examples has a second act, and the second acts prove his point more emphatically than he could have known at the time.
Know What You Own
Lynch opens with what he calls the single most important thing in the stock market: know what you own. His estimate was that around 80 per cent of the people who own shares could not tell you why they own them. If you press them, the real reason emerges. The sucker is going up. That is the whole thesis.
His test is disarmingly simple. If you cannot explain to a ten-year-old, in two minutes or less, why you own a stock, you should not own it. His proof was Dunkin’ Donuts. He understood it. In a recession, people still went there. No low-priced Korean imports were going to undercut a doughnut. He made ten or fifteen times his money on a business that required no special insight to grasp, only the willingness to look at it. For the record, Dunkin’ was bought by Inspire Brands in late 2020 for roughly $11 billion. The doughnut business, it turns out, was a serious business.
Lynch is not alone in this. Warren Buffett has spent six decades saying much the same thing in his own words: never invest in a business you cannot understand, and stay inside your circle of competence. When two of the most successful investors of the century reduce their method to the same sentence, it is probably worth writing down.
Peter Lynch
If you can’t explain to a ten-year-old, in two minutes or less, why you own a stock, you shouldn’t own it.
The second half of the same point is what I think of as the research paradox, and it is the part of the speech that has aged least, because it is about us rather than about any company.
People are careful with money in every domain but one. They read Consumer Reports before buying a refrigerator. They consult the Michelin guide before a trip to Europe. They ask around before choosing a car. Then they hear a tip on the bus and put half their life savings into a stock before sunset. When the stock falls, they blame the institutions and program trading. Lynch’s verdict was blunt: that is garbage. They did not look at the balance sheet. They bought a piece of junk, and they got what junk pays. A refrigerator receives a fortnight of due diligence; a company receives a bus ride.
The paradox is timeless, and it keeps finding new tellers. Naftali Horowitz, the JP Morgan managing director who is also a practising rabbi, makes the same observation with a modern example: people will happily spend an evening on YouTube learning to repair a small kitchen appliance to save a few dollars, and never spend an evening learning how to save and invest, which would make them thousands. I covered his thinking in Jewish Wisdom on Money and Life and, more fully, in You Revealed: Lessons from Naftali Horowitz. Thirty years and a different tradition, and the joke is the same, because the behaviour is the same.
He also noticed something more subtle. The belief that the public cannot win in the stock market is self-fulfilling. People invest badly, conclude the game is rigged, and then invest worse. The remedy is not a better tip. It is the recognition that there is a method, and that the method …“is not that complicated”.
There Is a Company Behind Every Stock
Lynch’s favourite illustration of the method involved two companies and what he called a magic number. Coca-Cola, in 1994, was earning thirty times per share what it had earned thirty-two years earlier, and the stock had risen thirtyfold. Bethlehem Steel was earning less than it had thirty years earlier, and the stock was at half its price of thirty years before. Stocks are not lottery tickets. There is a company behind every one of them. If the company does well, the stock does well. If it does not, it does not.
The epilogue is instructive. Bethlehem Steel filed for bankruptcy in 2001 and its remaining assets were sold off two years later. Coca-Cola is still selling the same drink and still raising its dividend. The relationship between earnings and price is not a theory. It is the only thing in the stock market that reliably holds over long periods, which is precisely why it is so easy to ignore over short ones.
From there Lynch moves to the thing people do instead of studying companies, which is trying to predict everything else. Nobody can predict the stock market. Nobody can predict interest rates: he pointed out, with the logic he learned at Boston College, that anyone who could call rates correctly three times in a row would be a billionaire, and there are not that many billionaires, so the syllogism rather takes care of itself. Nobody can predict the economy. Alan Greenspan, then chairman of the Federal Reserve, was honest enough to admit that he could not tell you where long-term rates would be in three years. If the head of the central bank cannot do it, the retail investor has no business trying.
If you spend fourteen minutes a year on economics, you’ve wasted twelve minutes.
He was careful to qualify that line, and the qualification matters more than the joke. He was dismissing economics as prediction: next year’s downturn, M1 and M2, the whole apparatus of forecasting. He was not dismissing economics as fact. When he owned car companies he watched used car prices. When he owned hotel stocks he watched occupancy rates. Chemical stocks meant knowing the price of ethylene; aluminium meant watching inventories; a housing stock meant home affordability. Those are facts, and facts can be worked with. Predictions cannot.
Howard Marks has turned this into something close to a mantra in his memos and interviews: you cannot predict, but you can prepare, and most macro forecasting is what he calls the illusion of knowledge. I covered his version in The Truth about Investing and made the same distinction from a different angle in Why Market Forecasts Always Fail, and What To Do Instead.
In fairness to the record, Lynch did venture one forecast that afternoon. The Dow was around 3,800. Corporate profits, he said, have historically grown at roughly 8 per cent a year, which means they double every nine years, so the market ought to double in the next eight or nine years. He was wrong. It doubled in about three.
Still, we are talking about average over a century. That is the sort of forecasting error most of us could live with, though it says rather more about the second half of the 1990s than about the method. Notice how the forecast was framed: he was not calling the market, he was describing the arithmetic of earnings.
Study History. The Market Goes Down, a Lot
If you are going to study something, Lynch says, study history, because the main thing history teaches is that the market goes down, and goes down a lot. He then did the arithmetic in his head for the audience. In the ninety-three years from 1900 to 1993 there had been fifty declines of 10 per cent or more, so roughly one every two years, again, on average!
Fifteen of those had been declines of 25 per cent or more, so roughly one every six years. A 10 per cent decline is called a correction, which he described as a euphemism for losing a lot of money rapidly. A 25 per cent decline is a bear market.
That is all you need to know, and if you are not ready for it, you should not own stocks.
But the second part of the argument is where Lynch differs from most people who cite those statistics. A decline is good when it happens, provided you understand what you own. If you liked a company at fourteen and it goes to six while the balance sheet is fine, and you were hoping to get to twenty-two, then fourteen to twenty-two is terrific and six to twenty-two is exceptional. The decline is the opportunity. The only people who cannot use it are the people who never knew why they bought in the first place.
Nobody will tell you when the decline is coming. Some people will tell you afterwards that they predicted it, and Lynch’s response is one of the best lines in the speech: they did predict it, fifty-three times.
Howard Marks built an entire investment philosophy on that observation, which I covered in Mastering the Market Cycles, and I have written about the practical side in How to Deal with a Bear Market. Lynch got there in two sentences and a joke.
You Have Plenty of Time, and More Edge Than You Think
People are in an unbelievable rush to buy stocks. Lynch said they were out of breath when they called him. His answer was Walmart. It went public in 1970 with fifteen years of results already behind it and a clean balance sheet. A cautious investor could have waited ten years, watching it move from state to state to make sure the model travelled, and still made thirty-five times their money.
Which brings him to the idea in the speech that I find most under-appreciated: edge. You need an edge to make money, and most people have one and throw it away. His example was Tagamet, the ulcer drug launched by SmithKline. You did not need to buy the shares during clinical trials, or when the results appeared in the Lancet. You could have waited a year or two after the drug was on the shelves. Every nurse, every pharmacist, every doctor writing prescriptions could see it worked, and could see that patients had to keep taking it or the ulcer returned, which is a poor deal for the patient and a wonderful one for the company. Buying two years after launch would have returned five or six times your money. Then Glaxo brought out Zantac, a better product, and the same people could have watched it take market share and tripled their money again. Instead, Lynch observed, millions of people who saw it first-hand were out buying oil drilling stocks.
PETER LYNCH
There are good stocks out there looking for you, and people just aren’t listening and they’re just not watching. And they have incredible edges. People have big edges over me.
National Press Club, 1994
The general rule he draws from it is worth writing down. When an industry goes from terrible to mediocre, the stock goes north. When it goes from mediocre to good, the stock goes north. When it goes from good to terrific, the stock goes north. If you work in an industry, supply it, or buy from it, you will see the turn before the analysts do. It does not happen every week, but it happens.
The edge is rarely exotic. It is the industry you already work in, supply, or buy from, observed with the attention you would give a refrigerator. I explored the broader principle in Invest Where You Have an Edge, and the tension between concentrating on what you know and spreading your bets in Diworsification or Diversification?.
Four Sentences That Cost Investors Money
The middle of the speech is a catalogue of phrases Lynch had heard from investors over the years, each of which sounds like reasoning and none of which is.
“How much lower can it go?” When Polaroid fell from 130 to 100, people said that if it ever got below 100 you should buy every share. It went to 95, and they bought. Within a year it was at 18, and this was a company with no debt. It was simply overpriced. Lynch confessed to the same error in his first years at Fidelity. Kaiser Industries had fallen from 26 to 16, so he bought one of the largest blocks ever traded on the American Stock Exchange at 14, on the grounds that it could hardly go lower. At 10 he called his mother and told her to look at it. It went to 6, then 5, then 4, then 3. At 3, the entire company was valued at about $75 million, which at the time would have bought one Boeing 747, and this for a business that owned 40 per cent of Kaiser Steel, 40 per cent of Kaiser Aluminum, a cement company, a broadcaster, an engineering firm and Jeep, with no debt. Eventually the company distributed its holdings to shareholders and the position was worth around $50 a share. The lesson he drew is the one that matters. He was right about Kaiser because he knew what it owned. If he had bought it only because it had fallen, he would have had no idea what to do at 9, or 8, or 7. That is the problem. People sell because they never knew why they bought, and once the price falls they have nothing to consult. Lynch’s suggestions for the alternatives, flipping a coin, walking around the block, psychiatry and prayer, had not, in his experience, worked.
It’s very hard to go bankrupt if you don’t have any debt. Some people can approach that. It’s a real achievement.
National Press Club, 1994
“Eventually they always come back.” They do not have to. RCA took until General Electric bought it to get back near its 1929 high. Double-knit fabrics never came back. Floppy discs and Western Union, as businesses their shareholders had bought into, did not come back either. A falling price is not a thesis, and a familiar name is not a balance sheet.
“It’s three dollars. How much can I lose?” Lynch’s answer required a piece of paper. If your neighbour puts $20,000 into a stock at 50 and you put $20,000 into it at 3, and it goes to zero, you lose exactly the same amount: everything. A low price is not a floor. He added a detail that is worth remembering the next time a cheap stock looks tempting. Short sellers, who actually make money on the downside, do not short Walmart or Johnson & Johnson. They short stocks that have fallen from 80 to 7, because they have worked out that the company is going to zero and it simply has not happened yet. They sell at 7, at 6, at 5, at 4, at 3, at 2, at one and a quarter. And to sell short you need a buyer. Who is buying? The people asking how much lower it can go.
“It’s a sure thing, keep it quiet.” Lynch bought about thirty long shots in his career and never broke even on one. The worst category he called whisper stocks: the phone call that begins with how are the kids and proceeds, in a lowered voice, to a company with enormous prospects that nobody else has noticed. His rule for these is short. If they are whispering, walk away.
Under all four sits one principle, and it is the one he asks the audience to write down. The stock does not know you own it. It is not your grandchild. You are not obliged to it and it feels nothing for you. If the fundamentals deteriorate, you say goodbye. If they keep improving, you stay. His best holdings, he said, were in their fifth, sixth and seventh years, not their fifth, sixth and seventh days.
Stomach Over Brain
The last third of the speech is about temperament, and it opens with a survey of everything people have worried about in Lynch’s lifetime. In the 1950s the fear was a return to depression, on the theory that only the war had ended the last one, plus nuclear annihilation. Schoolchildren practised getting under their desks, a procedure Lynch found unconvincing even at the time. People would not buy stocks. The 1950s turned out to be the best decade of the century for the stock market, with the 1980s the only rival. Then oil went from four dollars to forty and was going to a hundred, and there would be a depression. Three years later the same experts had oil at ten and going to four, and there would be a depression. Then Japan was going to own the world, and there would be a depression. Two years after that Japan was going to collapse, and there would be a depression. Then it was the debt of the less developed countries, which had by then been renamed emerging markets, and there would be a depression.
There is always something to worry about. It is never the thing that actually happens, and – financially – it is rarely as bad as advertised. What Lynch draws from this is not optimism exactly. It is the recognition that the worrying is a permanent feature of the environment and therefore carries no information. You cannot wait for it to clear, because it will not.
The key organ in your body in the stock market is your stomach. It’s not the brain. If you can add eight and eight and get reasonably close to sixteen, that’s the only level of maths you need to know.
National Press Club, 1994
He then puts the temperament question in a form every investor should answer before buying anything. What am I going to do when the market goes down? Not if. When. He used to ask large audiences how many of them were short-term investors, and nobody ever raised a hand. Everyone in the world, he concluded, is a long-term investor until the market goes down. If you cannot answer the question in advance, the market will answer it for you, usually at the bottom.
His case for equities over the long run rests on one observation about corporate behaviour. No company has ever called a meeting to say that things are going so well it ought to raise the coupon on its bonds as a reward to loyal bondholders. Companies do, however, raise their earnings, and a few of them do it with astonishing consistency. Automatic Data Processing, which runs payroll and could not be more prosaic, had at that point delivered thirty-two consecutive years of double-digit earnings growth, through recessions, wars and every change of government. Johnson & Johnson had thirty years of rising earnings, Genuine Parts forty-two, Emerson Electric thirty-eight. Put money in regularly, into a fund if you cannot follow companies yourself, keep adding, and in ten, twenty or thirty years stocks will beat money markets and bonds comfortably. The lever is the earnings. Everything else is weather.
The section of the speech I most wish more people had heard is the one on investor education, because it is where Lynch stops being a stock picker and starts sounding like someone who has thought about the public. There is, he said, an incredible rate of financial illiteracy. He was not telling anyone to buy a stock. He was saying that if you buy one, there are things you ought to do, and if you are not willing to do them, or do not have the stomach for it, you should keep your money in the bank and do nobody any harm. He was particularly exercised by people who had saved fifty or sixty thousand dollars for a child’s university fees, due the following year, and put the lot into an equity fund. What people need, he said, is a menu, like the one you get at a Howard Johnson’s: an emerging growth fund invests in companies with fifty million dollars in sales and is far more volatile than a fund of blue chips; a long bond swings more than a medium one, which swings more than a one-year bond. None of this is difficult. It is simply not explained. Thirty years later, that remains the founding complaint of this website, and I have written about the poor state of adult financial education more than once.
Poker, Not Chess
Lynch closes the question session with an analogy that has since become common currency but was, in 1994, still fresh. More people should study poker, he said, and fewer should study chess. In chess everything is on the board. All the moves are known, and an outstanding player will beat a good one a thousand times in a row, because it is pure technique. In poker, and in bridge, there are things you do not know. You can play a hand exactly right and lose. What you say afterwards is: I played it right, and if I keep doing that over a night, over a month, I will come out ahead. That, he said, is the stock market. It is much closer to poker than to any other game.
Michael Mauboussin later built an entire framework on that distinction between skill and luck, and on the discipline of judging decisions by process rather than outcome (YouTube video).
WHAT TO TAKE FROM THE SPEECH
Know what you own. If the two-minute explanation to a ten-year-old fails, so will the investment.
There is a company behind every stock. Earnings drive prices over any horizon that matters. Study companies, not forecasts.
The market falls by a tenth roughly every two years and by a quarter roughly every six. Decide now what you will do when it happens.
You have time, and you have an edge in the industry you already know. Use it, or at least stop throwing it away.
A low price is not a reason. A famous name is not a reason. A whisper is a reason to leave.
The stock does not know you own it. Stay while the fundamentals hold and say goodbye when they do not.
The key organ is the stomach. Play the long run, not the single hand.
Watch the Lecture
I have cut and annotated the speech into a video that follows the structure above, with the examples on screen and the later chapters added where they change the picture. Lynch is funnier in person than on the page. Make sure to watch his lecture.
Keep it real. Sweat Your Assets.