Book Review by William Somers: One Up On Wall Street

Editor’s Note: This is the 15th book review we are publishing as part of our Get Paid to Read contest. Last week, we published The Art of Strategy by Avinash K. Dixit and Barry J. Nalebuff which was reviewed by Sanjay Narang.

You can explore the rest of the reviews we’ve published in the Reading List section here.

This week, William Somers reviews One Up On Wall Street. William Somers, a former CTA, is passionate about reading and writing about financial markets and currently resides in New York.

One Up On Wall Street along with You Can Be A Stock Market Genius are two of my favorite books and I am glad Mr. Somers decided to review the book.

The best books for the amateur investor offer lessons that are simple, fundamental, and timeless – and bear rereading because the lessons are easy to forget if you do not invest in stocks for a living. “One Up on Wall Street” by Peter Lynch is one of the classics of the genre and serves up these lessons in a breezy and humorous style, and with the credibility of genuine expertise. This credibility rests on the extraordinary performance of the Fidelity Magellan Fund’s while Lynch managed it from 1977 to 1990, returning 29% per year versus 13% for the S&P 500. He attributes his success to finding “tenbaggers”, his term for stocks that appreciate ten times, and in “One Up” says that finding ten-baggers is something anyone can do.

Published in 1989, One Up On Wall Street was an immediate hit. It arrived at a time when the mutual fund industry was growing rapidly. Magellan alone grew its assets from $18 million to $14 billion over Lynch’s tenure. Congress had enacted the Internal Revenue Code Section 401(k) in 1978, and companies began moving from defined-benefit to defined-contribution plans. Deductible IRA’s had been introduced four years earlier.  Americans had been handed the keys to — and made responsible for — their financial security, and mutual funds were the vehicle parked conveniently at the door to this new financial freedom and era of responsibility.  It became obligatory to have at least a passing familiarity with the stock market, if not a solid understanding, and One Up On Wall Street sets out to make it eminently understandable.

One Up On Wall Street starts with music to individual investors’ ears:

“Twenty years in this business convinces me that any normal person using the customary three percent of the brain can pick stocks just as well, if not better, than the average Wall Street expert.”

This is because individual investors enjoy certain advantages relative to professionals: local knowledge, flexibility, long-term perspective, less bureaucracy, focus on fewer stocks, personal commitment, and lower overhead costs. Countless studies have shown overhead costs – in the form of management fees – are why actively managed equity funds, on average, underperform relative to the market. What of the other reasons?

Lynch suggests that individual investors are at an advantage because they are free from the institutional constraints faced by professional investors and from, what is the other side of that coin, career risk, summed up by Keynes in his quip, “It is better for reputation to fail conventionally than to succeed unconventionally.” Lynch’s equivalent summary is characteristically blunt: “Success is one thing, but it’s more important not to look bad if you fail. There’s an unwritten rule on Wall Street: ‘You’ll never lose your job losing your client’s money in IBM.’”  Not having to worry about short-term – or any — performance pressure and motivated by passion, individual investors can take advantage of “local knowledge” to make concentrated bets on companies they know best. As Lynch puts it, “grassroots observers can spot [an opportunity] six to twelve months ahead of regular financial analysts.”

Lynch puts his money where his mouth is, with ten-baggers in, for example, Taco Bell (“impressed with the burrito on a trip to California”) and  Dunkin’ Donuts (“loved the coffee”), although this can approach can backfire, as happened with his investment in the sandwich shop where he got lunch every day — down 95%, or a one-twentiethbagger.  (He is refreshingly forthcoming about his investment misadventures.)

Lynch offers a framework for evaluating companies and plenty of sensible advice that, taken together, amount to conventional valuation analysis – conventional in a good way, because it is based on sound fundamental principles. First, categorize companies into one of six groups: turnarounds, slow growers, stalwarts, fast growers, cyclicals, and asset plays; for each, there is a different set of criteria to apply.

“Fast growers”, companies with a product demonstrating explosive growth, is a favorite category and the most likely source of tenbaggers. For a fast grower, it is essential to evaluate its star product’s penetration versus the total potential market to confirm there is room to grow, how meaningful that product is to the company’s bottom line and therefore its stock price, and the P/E, which should be lower than the company’s projected growth rate, among a host of other considerations such as competitive positioning and barriers to entry.

Turnarounds were another important source of Lynch’s greatest successes, including Chrysler, the single biggest winner for Magellan in absolute dollar terms. Along the way, Lynch has plenty to say about profits, cash flow, dividends, share buybacks, book value, debt ratios, P/E ratios, and other elements of stock valuation that individual investors should be willing, with rolled up sleeves and sharpened pencils (if not green eyeshades), to analyze.

In the age of passive investing, when so many have been convinced they can’t beat the market consistently, One Up On Wall Street’s assertion that anyone can outperform the professional investor seems quaint, if not facile. The insights and emphasis on rigor of the rest of the book, however, bely the seductive prospect of easy riches one would be forgiven for inferring from the introductory pages. What makes it worth reading today is the soundness of the analytical approach it recommends, the humorous anecdotes that Lynch (with credit to his co-author, the excellent John Rothchild) recount on almost every page, and the chance to celebrate again one of the truly great success stories in the annals of investing, the heyday of Fidelity’s Magellan.