Peter Lynch Was Wrong — Don’t Invest In What You Know

I love Peter Lynch.

There. I said it. And I say it with­out embar­rass­ment, even though I’m about to spend the next few hun­dred words pick­ing apart one of his most famous pieces of advice.

Lynch is one of the great­est investors who ever lived. Full stop. His thir­teen-year run man­ag­ing the Mag­el­lan Fund at Fideli­ty — turn­ing $18 mil­lion into $14 bil­lion and aver­ag­ing a 29% annu­al return — is the kind of num­ber that makes you ques­tion whether the laws of physics apply to him. He was also that rare thing: a fund man­ag­er who could actu­al­ly explain what he was doing in plain Eng­lish.

The quotes alone are worth the price of admis­sion.

“The per­son who turns over the most rocks wins the game.”

“If you spend more than 13 min­utes ana­lyz­ing eco­nom­ic and mar­ket fore­casts, you’ve wast­ed 10 min­utes.”

“Go for a busi­ness that any idiot can run – because soon­er or lat­er, any idiot prob­a­bly is going to be run­ning it.”

And, on a per­son­al note, this one has defined my life since I left Microsoft and start­ed the world’s first pod­cast net­work twen­ty years ago:

“Find some­thing you enjoy doing and give it every­thing you’ve got, and the mon­ey will take care of itself.”

One Up On Wall Street and Beat­ing the Street are absolute clas­sics. I have enor­mous respect for the man.

But not every bon mot of wis­dom can be tak­en as good invest­ing advice with­out a lit­tle con­text and per­spec­tive.

Take his famous line: invest in what you know.

What People Think He Meant

I have heard this trans­lat­ed, more times than I can count, as: “I like Apple prod­ucts, I under­stand Apple prod­ucts, there­fore I should invest in Apple.”

Or: “I shop at Cost­co every week, I know how good the hot dogs are, time to buy some stock.”

It’s a seduc­tive idea. You feel like an insid­er. You have infor­ma­tion. You eat the Dunkin’ Donuts, there­fore you under­stand the busi­ness. Buy.

The prob­lem is that this is almost exact­ly back­wards.

What He Actually Meant

Here’s the thing — Lynch him­self antic­i­pat­ed this mis­read­ing and cor­rect­ed it, right there in One Up On Wall Street. This is the pas­sage most peo­ple skip:

“How­ev­er a stock has come to your atten­tion, whether via the office, the shop­ping mall, some­thing you ate, some­thing you bought, or some­thing you heard from your bro­ker, your moth­er-in-law, or even from Ivan Boesky’s parole offi­cer, the dis­cov­ery is not a buy sig­nal. Just because Dunkin’ Donuts is always crowd­ed or Reynolds Met­als has more alu­minum orders than it can han­dle does­n’t mean you ought to own the stock. Not yet. What you’ve got so far is sim­ply a lead to a sto­ry that has to be devel­oped. In fact, you ought to treat the ini­tial infor­ma­tion as if it were an anony­mous and intrigu­ing tip, mys­te­ri­ous­ly shoved into your mail­box.”

In oth­er words: famil­iar­i­ty is a start­ing point, not a con­clu­sion. A lead, not a the­sis.

When Lynch talks about “know­ing” some­thing, he means the kind of deep, struc­tur­al insight you have because you work in an indus­try. Not “I eat at McDon­ald’s” but “I’m a sup­ply chain man­ag­er in the fast food sec­tor and I can see things that out­siders can’t.” Not insid­er trad­ing secrets — just the mechan­ics of an indus­try, under­stood from the inside.

And even then, he’s clear: do your research. Know­ing the indus­try is just the first shov­el in the ground.

“Invest­ing with­out research is like play­ing stud pok­er and nev­er look­ing at the cards.”

Fair enough, Peter. We agree on that.

Here’s Where QAV Goes Further

But here’s where I’d gen­tly part ways with Lynch, even on his cor­rect­ed ver­sion.

Because I don’t know a lot about any com­pa­ny or sec­tor. I can talk until the cows come home — and often do — about why Julius Cae­sar crossed the Rubi­con, why Fidel Cas­tro over­threw the Batista regime, or why Leonar­do da Vin­ci was obsessed with the tongues of wood­peck­ers. But none of that helps my invest­ing.

I have no spe­cial insight into almond farm­ing. I could­n’t tell you the first thing about what makes one com­mer­cial office rental com­pa­ny bet­ter than anoth­er. I have nev­er once in my life thought deeply about the logis­tics of indus­tri­al scaf­fold­ing.

And yet — some of the best per­form­ing stocks in our port­fo­lio have come from exact­ly those kinds of busi­ness­es.

Tony has taught me that the research that mat­ters isn’t about the busi­ness. It’s about the num­bers. It’s about lis­ten­ing to what the finan­cial state­ments are telling you.

Is the com­pa­ny mak­ing mon­ey? Is man­age­ment eat­ing their own cook­ing — do they own a mean­ing­ful stake? Is rev­enue grow­ing con­sis­tent­ly? What does the bal­ance sheet look like? Is it finan­cial­ly sta­ble?

Before I buy a stock, I’ll take a quick look at who the com­pa­ny is and what they do — most­ly just to make sure they’re not in the mid­dle of a merg­er, sell­ing off a limb, or about to be delist­ed. That’s about the extent of it. I don’t need to under­stand their prod­ucts. I don’t need to have used their ser­vices. I don’t need a per­son­al con­nec­tion to the busi­ness at all.

I just need to know that it rep­re­sents a fair com­bi­na­tion of qual­i­ty and val­ue.

Knowing Why You Own It

Lynch had one more line that I actu­al­ly think is the best thing he ever said about this:

“Know what you own, and know why you own it.”

I love this. And I believe it com­plete­ly.

Here’s the thing though — even though I might not know much about what a com­pa­ny does, I always know exact­ly why I own it. It passed the check­list. The num­bers stack up. Qual­i­ty is there, val­ue is there, man­age­ment is aligned. That’s why I own it.

That’s all the “know­ing” I need.

Lynch was right that famil­iar­i­ty can open a door. But in QAV, we’ve realised that the door was nev­er locked in the first place. Any com­pa­ny’s finan­cials are pub­licly avail­able. The infor­ma­tion isn’t hid­den. You don’t need indus­try exper­tise to read a bal­ance sheet.

You just need to know what you’re look­ing for.

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QAV Myth Killers is a week­ly col­umn in the QAV newslet­ter, tak­ing apart a piece of
invest­ing con­ven­tion­al wis­dom. Read the series, or
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