Feb

17

Back in 1992 I read Peter Lynch's book "Beating the Street". It's a fun book to read; he explains how he came to recommend ~20 stocks in that year's Barron's "Roundtable". As the years passed though I kept noticing that stocks that he had recommended were falling by the wayside. One of them, Sun TV and Appliance, was a retailer in Columbus, Ohio, where I was living at the time, and not too many years after the recommendation, Sun crashed and burned. Similarly I noticed bad things happening to Supercuts, which he recommended, and more recently Fannie Mae and GM both fell to zero-ish levels. So I've long suspected that overall his picks might have been sub-par, or a disaster, even.

Today I finally got had the time and energy to test it. I know this is breaking the rules, but please refer to the attached spreadsheet, only 10 kB. The spreadsheet shows Lynch's 18 stocks (I excluded one stock because it traded in London and another because it was a "Class B" share, and I couldn't figure out what ticker to use in my database) and their tickers as of 1/31/1992.

Many, actually most, of the stocks did not continue as going concerns until today; they were either acquired, bankrupted, or whatever. I believe that my database (MarketQA) does a reasonably good job of giving my a terminal value, but beyond that I didn't attempt to find out what happened to each stock.

So the spreadsheet has a column for "months as a going concern", i.e. how long the stock lasted after 1/31/1992 until it was acquired, bankrupted, or whatever. Stocks that survived until now have lived for 229 months. The next column, "$1 grew to" tells you how much money you'd have if you invested $1 and held until the firm ceased as a going concern. The last column gives the compound return over the period as a going concern.

Lynch didn't do badly at all. The average stock grew $1 into $4.24. On average the stocks "lived" for 141 months as going concerns, and I did not give Lynch any credit for reinvesting the moneys after stocks died off. However there was an enormous variation among the stocks. Five of the 18 stocks lost more than 90%, but four multiplied your money by a factor of 10 or more.

The big winners were in the thrift / S&L stocks–on average they grew $1 into more than $8, and without them the average performance of the remaining stocks is not impressive.

Lessons? I guess these results give a pretty good feel for the wide variation in returns of individual stocks over long periods. It may also be surprising that stocks have such finite lifetimes, even when they work out well–e.g. First Essex turned your $1 into $20 before it fell off the radar about ten years ago, presumably after being acquired. Lynch himself always emphasizes that the occasional "ten bagger" can make up for a lot of sins elsewhere in the portfolio, and that definitely played out with his picks.

(If you can't handle spreadsheets, here it is as text, but I have no idea whether it will format properly for you.)

ticker as of 1/31/1992    company name    months as a going concern    $1 grew
to    compound annualized return while a going concern
GH    General Host    72    $0.80    -3.6%
PIR    Pier 1 Imports    229    $2.88    5.7%
SBN    Sunbelt Nursery    74    $0.03    -44.7%
CUTS    Supercuts    57    $0.72    -6.7%
SNTV    Sun TV and Appliance    82    $0.03    -40.0%
EAG    Eagle Financial    75    $6.34    34.4%
FESX    First Essex Bancorp    145    $19.57    27.9%
GSBK    Germantown Savings Bank    35    $3.67    56.1%
GBCI    Glacier Bancorp    229    $12.70    14.2%
LSBX    Lawrence Savings Bank    229    $10.54    13.1%
PBNB    People's Savings Financial    66    $3.97    28.5%
SVRN    Sovereign Bancorp    204    $1.03    0.2%
TLP    Tenera L.P.    139    $0.00    -42.8%
GM    General Motors    226    $0.01    -23.7%
PD    Phelps Dodge    182    $10.64    16.9%
CMS    CMS Energy    229    $1.74    2.9%
FNM    Fannie Mae    229    $0.04    -15.5%
COGRA    Colonial Group    38    $1.67    17.6%

       average    $4.24

Steve Ellison writes:

The median stock turned $1 into $1.70 and had a 4.4% CAGR. I got similar results when I checked stocks suggested by Jim Collins in Good to Great. A small number of big gainers made the portfolio as a whole above average. Maybe there is a lesson here.

Tim Melvin comments: 

If you study Mr. Lynch's results much of his success was a result of playing the mutual thrift conversion game. His fund had deposts in just about every mutual thrift in the country so he could buy the conversion offering. Almost universally these stocks were HUGE winners. That game is very much back to life today as new regs are pretty much forcing many thrifts to convert…..most can be bought after the offering at a still sizable disocunt to tangible book value.

Charles Pennington writes: 

Of the four "ten baggers", two would have gotten stopped out at very disadvantageous (roughly break even) prices…

I would have guessed that those conversions had limits on how much stock a customer could buy, and with those limits in place, how could they make a dent in the performance of a large fund?

According to the Cramer book ("Confessions.."), which is very entertaining, much of the good performance of his fund was also due to holding thrifts, but he almost went under when redemptions threatened to force him to sell those very illiquid stocks.

Apart from the initial "pop" after a conversion, I don't see why thrift stocks would continue being cheap. Isn't this a very well-known idea, given that I've heard of it?

Victor Niederhoffer writes:

Now the professor is going to compute the market value of the individual stocks and tell me that the average market value of the ones that went down 100% at inception was not different from the average market value of the ones that were 10 baggers and kept him from reading books. 

Charles Pennington responds: 

The Chair's point is that most of the 10 baggers mostly started out as impossibly-small-to-buy stocks, and that is correct. Here are the 10-baggers and their market caps in January 1992:

First Essex (FESX) $21 million
Glacier Bancorp (GBCI) $32 million
LSBX $12 million
Phelps Dodge (PD) $2.6 billion

The only non-micro cap is Phelps Dodge.

Here are the January 1992 market caps of the stocks that lost nearly 100%:

SBN $60 million
SNTV $109 million
TLP $30 million
GM $19.9 billion
FNM $17.7 billion

George Coyle writes: 

Food for thought since I don't have access to data, certain funds and firms have size restrictions on what they can buy due to position sizing, liquidity, etc. It would be interesting to see if stocks which crossed over a given level in market cap ($100mm, $500mm, $1bb) subsequently saw inflows or outflows by virtue of qualifying as new investments for bigger buyers or being kicked out by virtue of falling below an acceptable cap level. Also, there are legal filing consequences of holding positions over certain sizes so I imagine patterns exist which are very real as firms alter position sizing to avoid regulatory filings (and ultimately position size disclosure on a non-quarterly basis). It is a bit of a momentum study meets the analysis below but with a legal/fund guideline slant. I believe Factset tracks historical cap sizes with some reasonable degree of accuracy/frequency but I no longer have access.

Phil McDonnell writes:

To throw a few stats on the table I am posting links to some work done by Eric Crittenden. He is a momentum quant with BlackStar Funds. He argues that trend following must work because long term stock distributions have very fat tails. He also argues that the negative fat tail implies that stop losses must work. One of the charts shows a huge right tail of three baggers or better. Another shows that all gains come from 20% of the stocks.
 
I have had the chance to review several of his studies in progress and Crittenden seems to do it right. He uses total returns and avoids obvious pitfalls like survivor bias etc.

Charles Pennington responds:

It seems kind of silly that they take this indirect route — "lots of big gainers and lots of big losers, therefore use stop losses". Why don't they just test the performance of some simple stop-loss rule? Jason proposed a trailing stop of 50%. That sounds ok to me. Then, whenever you're stopped out, use the proceeds to buy an equal weight (cap weighted) of the remaining stocks. Does that outperform or under-perform the equal-weight (or cap weighted) index?


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