The crypto rollercoaster just doesn’t stop, especially when Elon Musk gets involved. After tanking the crypto market by 10% following his Bitcoin rebuke, Musk pumped crypto again with a cryptic Dogecoin tweet.
This inexplicable behavior has made a lot of people angry, as thousands lost money and sold, only to see the price spectacularly rise again. If you’re one of those people that’s sick of the crypto rollercoaster, don’t be discouraged.
Investing does not need to feel like a casino. One billionaire investor has a strategy that is the polar opposite of the crypto roller-coaster ride.
Peter Lynch, former manager of the Magellan Fund is not shy in sharing his investment strategies. He too believes that ordinary people should be investing. But, he favored stocks.
In the long run, stocks have outperformed every other kind of financial asset. Stocks have outperformed gold and they may, in the end, outperform “digital gold,” or cryptocurrencies.
Obviously, cryptocurrency gains in recent years were stronger than the stock market. But stocks are a far less speculative asset.
A stock is a title in a company’s ownership. Owning stocks is like owning a small piece of a company. If the company is in a good shape, the stocks will very likely go up. That’s something you can count on, at least in the long run.
Lynch claimed that by learning how to pick good companies, ordinary people can achieve sustainable and high returns. Using that strategy, he netted over 2700% in returns between 1977 to 1990, before he retired.
Focus on the Long Run
But what is his strategy? Far different than what many would expect. He did not worry about the daily movements of the stock. Lynch was a long-term investor.
But what happens if the stock drops? That should not discourage a long-term investor.
Within a given year, the value of the average stock fluctuates by about 50%. That’s an incredible amount of volatility. Obviously, cryptocurrencies are even more volatile, as many have recently found out.
His strategy was to look for good companies, buy their stocks and then just leave them be. He believed that long-term investors have an inherent edge.
“Absent a lot of surprises, stocks are relatively predictable over 10-20 years. As to whether they’re going to be higher or lower in two or three years, you might as well flip a coin to decide.” Lynch wrote in One Up On Wall Street, his bestselling book on investing.
When investing, it’s not wise to follow the crowd. As Warren Buffet once said: “In the short term the market is a popularity contest; in the long term it is a weighing machine.”
The Formula: P/E and PEG
The key factor in this strategy is the willingness to do the necessary in-depth research to find good investment opportunities. He advised looking at as many companies as possible.
“I always thought if you looked at ten companies, you’d find one that’s interesting, if you’d look at 20, you’d find two, or if you look at a hundred you’ll find ten. The person that turns over the most rocks wins the game,” Lynch said for PBS.
But what should investors be looking at? Growth of sales, revenue, and profits, good management, and a low debt-to-asset ratio.
Once the company is found to be sound, the investor should look if its stocks are cheap or expensive. That’s what its PE and PEG ratios tell him. The price-to-earnings (PE) ratio is the ratio between the price of the stock and the earnings-per-share.
The lower the PE ratio, the more affordable a stock is. The average PE ratio in the last 100 years was about 15, and at the moment it’s 23. This data can be used to assess the relative affordability of the stock as compared to the mean.
However, it’s also important to understand the PEG ratio, which is the ratio between a company’s PE ratio and its expected growth rate.
This is important a company that grows faster will be more valuable in the future, so investors will tolerate a higher PE ratio of its stocks.
Tech stocks typically have very high PE ratios, as they tend to grow fast. For example, Alphabet’s PE ratio in 2021 was about 30, while Apple’s PE was 50.
As the PEG ratio divides PE by expected growth rate, a company with a PEG ratio of about 1 could be said to be fairly valued. If a stock’s PEG is below one, it could be a bargain.
‘If You Spend 13 Minutes On Economics, You’ve Wasted 10 Minutes’
But what about the interest rate? A bear or a bull market? What about Fed policy, or inflation?
Lynch has a controversial, yet effective strategy to deal with these questions. Just ignore them.
“Thousands of experts study overbought indicators, head-and-shoulder patterns, put-call ratios, the Fed’s policy on money supply…and they can’t predict markets with any useful consistency, any more than the gizzard squeezers could tell the Roman emperors when the Huns would attack.”, Lynch stated in One Up On Wall Street, his bestseller.
“So I don’t worry about any of that stuff. I’ve always said if you spend 13 minutes a year on economics, you’ve wasted 10 minutes.”
Lynch’s reasoning is in line with what most free-market economists, especially Austrians, think about the market.
No one can predict what the market will do in the future. No one can predict the interest rate, no one can predict the S&P 500, or the currency rates.
But understanding a few companies and finding those that are undervalued? That’s something that we can do, and that the likes of Peter Lynch, Warren Buffett and others have been doing very successfully.
Timing The Market Just Doesn’t Pay
But what if there’s a recession just behind the corner? Fed’s money printing is bound to lead to hyperinflation!
“Far more money has been lost by investors trying to anticipate corrections than lost in the corrections themselves”, Lynch claimed.
“I don’t remember anybody predicting 1982 we’re going to have 14 percent inflation, 12 percent unemployment, a 20 percent prime rate, you know, the worst recession since the Depression,” Lynch said for PBS.
We know that the Fed’s easy money policy will ultimately lead to a market crash, or to a market crash with hyperinflation. But we don’t know when that will be.
We don’t know enough to safely cash out of stocks in time. And not being in the stock market, and losing +11% returns is out of the question.
But even if we could, it probably wouldn’t pay to do so.
Lynch conducted a study of market data from 1965 to 1990 to determine whether market timing was an effective strategy. He devised a hypothetical example as follows:
“Investor 1, who is very unlucky, somehow manages to buy stocks on the most expensive day of each year. Investor 2, who is very lucky, buys stocks on the cheapest day of each year. Investor 3 has a system: She always buys her stocks on January 1, no matter what.”
“You’d think that Investor 2, having an uncanny knack for timing the market, would end up much richer than Investor 1, the unluckiest person on Wall Street, and would also outperform Investor 3.
But over 30 years, the returns are surprisingly similar. Investor 1 makes 10.6% annually; Investor 2, 11.7%; and Investor 3, 11%. Even I am amazed that perfect timing year after year is worth only 1.1% more than horrible timing year after year.”
As surprising as that might sound, recessions don’t matter as much to the long-term investor.
As long as you resist the urge to speculate, and to buy something just because it is going up, you will probably be fine in the long run.
So, don’t feel bad for “missing out.”