Shopping for Stocks: How Peter Lynch Picked Retail Winners

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

Peter Lynch didn’t find his best stock ideas in analyst reports or at investment conferences. He found them at the Burlington Mall, 25 miles from his house.

He literally walked through the mall, watched which stores were packed with customers, and then went back to the office to research those companies. That was his system. And it worked better than most things Wall Street was doing.

The Mall as a Research Lab

Lynch calls the mall “a delightful atmosphere in which to study great stocks.” He’s not joking. He points out that $10,000 invested in 1986 in each of four popular retailers (Home Depot, the Limited, the Gap, and Wal-Mart) would have been worth more than $500,000 just five years later.

Those weren’t obscure companies. Millions of people shopped at them every week. The information was right there, for anyone paying attention.

Here’s the thing. Mall employees see what’s happening every day. Mall managers get monthly sales figures from every store. Anyone working in retail has better intelligence than most fund managers sitting in office towers reading spreadsheets. Lynch puts it bluntly:

If you like the store, chances are you’ll love the stock.

His Own Family Kept Beating Him

Lynch’s three daughters were his best stock scouts. And he kept ignoring them.

His daughter Annie asked if Clearly Canadian, the carbonated drink that filled their refrigerator, was a public company. Lynch looked it up, didn’t find it in the S&P book (it was listed on Canadian exchanges), and forgot about it. The stock went from $3 to $26.75. Nearly a nine-bagger in one year.

His daughters wore green Chili’s sweatshirts to bed. He ignored that signal too.

When his oldest daughter, Mary, started buying clothes from the Gap in 1990, Lynch finally realized he needed to stop dismissing these tips. But even then, he didn’t act on the Gap. If he had, he would have doubled his money in 1991 alone.

The Body Shop Discovery

Just before Christmas, Lynch took his three daughters to the Burlington Mall. He called it a “Christmas present trip” for them. It was really a research trip. He wanted them to lead him to their favorite store.

They went straight to the Body Shop. The place sells lotions and shampoos made from bananas, nuts, berries, and something called Rhassoul mud. Not exactly what Lynch would put on his own shopping list. But the store was packed. It was one of the three most crowded stores in the entire mall.

Back at the office, Lynch discovered he had actually bought shares in the Body Shop back in 1989 and completely forgotten about it. That’s what happens when you’re tracking 1,400 companies.

He dug into the numbers. The Body Shop was a British company started by Anita Roddick, who began tinkering with potions in her garage. It went public in 1984 for about 10 cents a share and turned into a 70-bagger in six years.

A few things made the story compelling. Canada had 92 Body Shops and was the most profitable retailer by sales per square foot. The U.S. had only 70 outlets. Lynch figured if Canada could support 92, America could support at least 920. That’s a lot of room to grow.

The company expanded through franchises, so it didn’t need to borrow money. And the chairman personally flew from England to inspect new franchise locations. Even when it was the franchisee’s money at risk. That level of care impressed Lynch.

The Catch: Valuation

The Body Shop had a p/e ratio of 42. That’s expensive by any standard. Lynch’s own rule of thumb says a stock should sell at or below its growth rate. The Body Shop was growing at 30 percent but priced at 40 times earnings.

But Lynch compared it to Coca-Cola, which was growing at 15 percent and selling at 30 times earnings. Between those two, he preferred the faster grower, even at the higher multiple. A company growing faster will eventually catch up to its price.

His advice for situations like this: make a small commitment and add more when the stock pulls back.

What to Look For in Retail Stocks

Lynch lays out a simple framework for evaluating retailers. These are the things that matter most.

Same-store sales. This is the most important metric. If existing stores are selling more year over year, the concept is working. If same-store sales are flat or declining while the company keeps opening new locations, that’s a warning sign.

Expansion pace. Growth is good. Too-fast growth funded by debt is dangerous. Lynch prefers companies that expand carefully and prove themselves in one area before moving to the next.

Inventory levels. When inventories pile up beyond normal, it can mean the company is hiding poor sales. Eventually they’ll have to mark everything down and admit the problem.

Balance sheet strength. Retailers with too much debt often don’t survive recessions. Franchise models are especially attractive because they expand with other people’s money.

You Don’t Have to Rush

The best part about retail stocks, Lynch says, is how much time you have. You don’t need to invest while someone is still testing recipes in a garage. You can wait until the concept is proven in one region, then another, and still make fantastic returns.

Wal-Mart went public in 1970 with 38 stores. If you waited until 1980, after the stock had already gone up 20-fold, you would have made another 30-fold from there. Even in the 1970s, Wal-Mart was only in 15 percent of the country. That left 85 percent still to go.

A stock doesn’t care who owns it or when they bought it. If the company still has room to grow, the math still works.

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