Magellan's Later Years: Peter Lynch's Adventures at Scale

Book: Beating the Street by Peter Lynch with John Rothchild | ISBN: 978-0-671-75915-5

By mid-1983, Lynch owned 450 stocks. By fall, that number had doubled to 900. He had to be ready to tell 900 different stories to his colleagues in 90 seconds or less. Which meant he actually had to know all 900 stories.

The critics said this was insane. A fund with 900 stocks was basically the market itself. Lynch was accused of managing the largest closet index fund on the planet.

But that missed the point entirely. Of those 900 stocks, 700 accounted for less than 10% of the fund’s total assets. They were tiny positions, starter bets in small companies or uncertain ideas. Lynch called them “tune in later” stocks. Owning a small position got him on the mailing list so he could follow the story. If the story improved, he’d buy more.

Peter’s Principle #9: “Not all common stocks are equally common.” A fund with 1,000 stocks in unusual companies will zig when the market zags. An unimaginative fund with 50 widely held blue chips creates a miniature S&P 500. The number of stocks tells you nothing about whether a fund can excel.

How a Tiny Holding Led to a Triple

Jan Bell Marketing, a small jewelry supplier, came to Fidelity for a meeting. Lynch owned a small position, so he showed up. No other fund managers bothered. The company was too small to matter.

But during the presentation, the executives mentioned that their best customers were the discount clubs: Pace, Warehouse, Wholesale, Costco. These clubs were ordering so much jewelry that Jan Bell could barely keep up. Lynch figured if they were selling that much jewelry, their overall sales must be excellent too.

He had analyst Will Danoff do the research. Wall Street had abandoned these stocks after a post-IPO selloff. Not a single analyst was assigned to follow them. Lynch and Danoff called the companies directly. Business was terrific. Balance sheets were stronger. Earnings were growing while stock prices were still falling.

Lynch bought hundreds of thousands of shares of Costco, Wholesale Club, and Pace. All three made money. Costco was a triple.

Adventures Abroad

Lynch was among the first domestic fund managers to invest heavily in foreign stocks. In 1984 he started his global buying in earnest. Nobody had a system for reliable foreign stock quotes, so his traders called Stockholm, London, Tokyo, and Paris every night to piece together the information.

His most successful trip started in September 1985. Three weeks, 23 companies, multiple countries. Sabena Airlines lost his luggage. His host’s husband miraculously had his exact measurements, so Lynch got fitted in a proper Swedish suit. With his white hair, everyone on the street thought he was Swedish and kept asking for directions in a language he doesn’t speak.

He visited seven Swedish companies in two days, including Aga (which makes profit literally out of thin air by selling industrial gases) and Skandia insurance.

Skandia was the find. Insurance rates had already been approved to increase, which should have boosted the stock, but Swedish investors ignored the good news and focused on lousy current earnings. Lynch checked for hidden problems. Too much debt? Junk bond exposure? Risky policies? The answer to everything was no. This was a conservative insurer guaranteed to double its earnings. The stock quadrupled in 18 months.

He drove to Volvo and found the stock at $34 per share while the company had $34 per share in cash. Buying the stock meant you got the entire auto business, all the plants, and Volvo’s many subsidiaries for free. You’d never find a deal like that in the U.S. among large companies. That’s why Lynch went to Europe.

The trip continued through Norway, Germany, and Italy. He listed Montedison, IFI, Olivetti, and The Last Supper as his favorite northern Italian attractions.

Peter’s Principle #10: “Never look back when you’re driving on the autobahn.” He learned this passing a car at 120 mph and discovering a Mercedes three inches from his rear bumper.

His top eleven foreign purchases made over $200 million in profits.

Beyond $5 Billion

By 1986, Magellan passed $5 billion. He needed $100 million positions to move the needle. One day at Yosemite, he spent two hours on the phone with traders and only got from A through L. His company visits escalated from 214 in 1980 to 570 in 1986.

Peter’s Principle #11: “The best stock to buy may be the one you already own.” Fannie Mae was a minor holding until Lynch rechecked and discovered the story had improved dramatically. Soon it would take over from Ford and Chrysler as the key to Magellan’s success.

The Great Correction

In 1987, Magellan became a $10 billion fund. Then the market crashed.

Lynch didn’t see it coming. He entered fully invested with almost no cash. Before the crash, Magellan was up 39%. His wife asked how he could complain about lagging the S&P by 2%. By December, the gain had become an 11% loss.

Peter’s Principle #12: “A sure cure for taking a stock for granted is a big drop in the price.”

During nine major declines, Magellan always fell harder than the market, then outperformed on the rebound. Lynch was golfing in Ireland when the crash hit. He had to sell stocks to cover $1.3 billion in redemptions. But most shareholders stayed put.

After the crash, he sold autos and moved into growth stocks. Philip Morris became his biggest position. He learned the importance of getting out of cyclicals at the right time. Chrysler earned $4.66 per share in 1988. People expected $4 for 1989. Instead it earned $1. By 1991 it was losing money. Lynch had already sold.

Magellan gained 22.8% in 1988 and 34.6% in 1989. Lynch beat the market for all 13 years of his tenure. Then he resigned, exhausted from 60-80 hour weeks.

Previous: Magellan’s Middle Years | Next: Art, Science, and Legwork