The Six-Month Checkup: How Peter Lynch Reviews His Portfolio

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

Buy-and-forget investing sounds great in theory. In practice, it can be dangerous. Lynch points to IBM, Sears, and Eastman Kodak as proof. All three were blue-chip giants. Investors who bought and forgot are sorry they did.

A healthy portfolio needs a regular checkup, roughly every six months. And no, looking up the stock price in the newspaper doesn’t count. That’s not research. That’s just checking a number.

The Two Questions

Every six months, Lynch asks two simple questions about each stock he owns:

1. Is the stock still attractively priced relative to earnings?
2. What is happening in the company to make earnings go up?

From there, you reach one of three conclusions. The story got better, so maybe buy more. The story got worse, so maybe sell. Or the story hasn’t changed, so hold or move the money somewhere more interesting.

In July 1992, Lynch ran this checkup on the 21 stocks he had recommended at the Barron’s Roundtable in January. As a group, they had returned 19.2 percent in six months. The S&P 500 had returned just 1.64 percent. But individual stocks told very different stories.

The Winners

The S&Ls crushed it. Germantown Savings was up 59 percent. Sovereign was up 64.5 percent. Eagle Financial jumped from $11 to $16. Glacier Bancorp climbed over 40 percent. First Essex, one of Lynch’s riskier picks, was up 70 percent. The riskiest stocks in the group delivered the greatest rewards, just as he expected. With interest rates falling, financial institutions were making huge money on the spread between what they charged for mortgages and what they paid on deposits.

Phelps Dodge was up 50 percent. One of the biggest winners, but Lynch warned that the easy money had already been made. It was a cyclical stock, and its future depended on copper prices, which no one could predict. He wouldn’t be buying more at this level.

General Motors advanced 37 percent before giving back some gains. Lynch still liked autos because car sales were several million below the normal trend. He saw good years ahead.

The Holds

The Body Shop fell 12.3 percent, which Lynch actually saw as a buying opportunity. The stock was now at 20 times estimated 1993 earnings, which he was happy to pay for a company growing at 25 percent. Same-store sales were up even during recessions in its four major markets. The company was buying its own suppliers to cut costs. And his friend who owned two Body Shop franchises reported strong sales, especially on something called mango body butter that kept flying off the shelves.

Pier 1 Imports bounced up and then fell back. Wall Street penalized the stock because first-quarter earnings came in at 17 cents when analysts expected 18-20 cents. Lynch thought this was an overreaction. The company had cut debt, reduced inventory, and kept expanding while its competitors, the department stores, were getting out of home furnishings entirely.

Colonial Group was doing well. Fund sales up 58 percent. Assets under management growing. A $10 million stock buyback announced. Still cheap at around $20 with $4 per share in cash.

CMS Energy was a hold with some risk. The stock had bounced around based on rumors about a rate case with the Michigan public service commission. Lynch was convinced it would work out long-term because energy demand was growing in the Midwest and nobody was building new plants. But in the short term, uncertainty was high.

The Disappointments

General Host and Sunbelt Nursery were struggling. General Host issued convertible preferred stock that diluted existing shareholders. Sales at its Frank’s Nursery stores were sluggish. Sunbelt was getting rained on. Literally. Too much rain in the Southwest killed enthusiasm for gardening.

But Lynch discovered something while checking on Sunbelt. Calloway’s, the best company in the nursery business, had also fallen in half. When the best company in an industry is selling at a bargain price, Lynch prefers to buy that one instead of a weaker competitor trading at a lower price. He’d rather own Toys “R” Us than Child World, Home Depot than Builder’s Square.

Supercuts had two problems. The franchise expert who knew how to roll out new locations had left the company. And a block of 2.2 million shares owned by Drexel Burnham Lambert’s creditors was hanging over the stock, waiting to be dumped. The business itself was fine. Same-store sales were up 6.9 percent. But Lynch worried about expansion pace. He told the CEO: “If you have a choice between reaching your goal in fifteen years or in five years, fifteen is better.”

New Discoveries Along the Way

This is one of the most valuable parts of the chapter. Lynch didn’t just review his existing picks. The research process led him to new ideas.

First Federal of Michigan was a $9 billion thrift that hadn’t budged while all his other S&L picks had soared. It was being held back by expensive debt from the Federal Home Loan Bank, but that debt was set to expire in 1994. When it did, earnings could jump from $2 to $4 per share. Book value was over $26. No coverage from Wall Street analysts.

Cedar Fair, the amusement park company, was acquiring Dorney Park near Allentown, Pennsylvania. The math worked out beautifully: the acquisition would immediately add to earnings. The stock didn’t move on the news. Lynch loved it when good deals got no reaction, because you could still buy at predeal prices.

Chrysler had already doubled in 1992, but Lynch put it back on his buy list. The company had $3.6 billion in cash, nearly enough to pay off all its long-term debt. The Jeep Cherokee and minivan were bringing in $4 billion a year. And the new LH car designs were about to launch. Lynch’s rule: rejecting a stock because the price already doubled can be a big mistake. What matters is whether it’s cheap today based on future earnings.

The Real Lesson

The six-month checkup is the unglamorous part of investing. Nobody writes articles about it. Nobody talks about it at parties. But it’s what separates serious investors from casual ones.

Lynch read quarterly reports from all 21 companies. He called most of them. Some stories had gone flat. Others had gotten more exciting. A few led him to entirely new companies he liked even better.

That’s how real stock-picking works. It’s not a one-time decision. It’s an ongoing conversation with the companies you own. You check in, ask questions, and adjust. The stock market is always moving. Your job is to keep up.

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