: “If you take the Fidelityfunds as a group, I haven't done this, but I'll bet if you took a dollar-weighted portfolio of the Fidelity equity funds - before load fees atleast - you would probably be in pretty good shape. You probably gotclose to or maybe even beat the indexes.” That’s quite a compliment.
Lynch: We’ve had so many good funds. There were the Destiny Iand Destiny II Funds which have been incredible funds. Equity IncomeI, Equity Income II, Growth and Income, Contrafund, New Millennium,Stock Selector, which we just mentioned, Puritan, we’re loaded withgood funds. Our Fidelity Growth Fund has beaten its peers and themarket by a wide margin over the last ten years. I’ve said that in the’80s, 75% of the funds didn’t beat the market. The same is true if youtake the last ten years. We’ve had lots of funds that have beaten theheck out of the market the last ten years.
Tanous:On another subject, Peter, I thought your piece inWorthmagazine [published by Fidelity] in which you defended corpor-ate downsizing and layoffs was rather courageous.
Lynch: The wrong people are being blamed. In the last 30 years,
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we've added 54 million jobs in America. Europe, which has a thirdmore people, has added 10 million jobs. Ten! They’re just starting todownsize in Europe. There are 20 million people out of work in Europe.That’s 11% of the workforce. We’re at 5 percent. The United Kingdomhasn’t added a job in over thirty years. The workforce is exactly thesame as it was in 1965. In the ’80s, the five hundred largest Americancompanies eliminated three million jobs. But the country added 18million jobs. In the so-called “greed decade,” we added 18 millionjobs! That’s because all these little companies started up and medium-sized companies grew. Together they added 21 million jobs. Theydon’t have that in Europe. You don’t have small and medium-sizedcompanies growing there. So if you blame all of business for layoffs,you miss the fact that there are a lot of people creating jobs. Youdon’t hear about those folks. You know, there were 2.1 million busi-nesses started in the 80s. At an average of ten jobs each, that’s 21million new jobs. You never hear about these folks. If you, me, andShirley start a business, you never hear about it.
When United Technologies lays off 5,000 people or AT&T lays off30,000, you hear about that. If you put together AT&T and their spin-offs, at the time they broke up the company they had a million em-ployees. One out of every 100 American employees worked for thetelephone company. If you put it back together now, they’d have lessthan 700,000 employees. They process twice the telephone calls, fiftytimes the data communications, a hundred times the faxes, a million-fold of cellular calls, with 30% fewer employees. Now, would Americabe better off if they had gone to two million employees? I would argueno. What you hope would happen is that most of the reduction wasfrom a lot of people who retired, while those who did get laid off hada good training program and help finding other jobs. You don’t wantto be harsh about this, but America is better off with a great telecom-munication system that is efficient and low cost. If they had threemillion workers, we’d be paying more for telephone calls.
Tanous:The overall unemployment rate didn’t go up. So can youeven argue that most people didn’t find work?
Lynch: Well, obviously some of them didn’t. But nobody likes tolay workers off. This theory that they’re a bunch of Scrooges whoenjoy saying “whom can we fire this week? Maybe we can find somepeople whose children are having medical problems and lay them off.That would really be bad,” is not the way it is. No one likes to lay off
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employees. It’s either you cut your workforce by 10 percent and sur-vive, or the whole hundred percent lose their jobs, like the Pan Amsof the world.
Tanous:Peter, why is everybody picking on your old fund, Magellan?It seems to be constantly in the press these days.
Lynch: I guess because it’s the biggest and | think there are nowfive people at The Wall Street Journal who cover mutual funds. Thereused to be nobody. More people own mutual funds than own stocksnow, so there’s a lot more coverage. And Magellan is the biggest fund.So it’s not surprising that it gets coverage. If you watch a basketballgame and at the end of the game the score is 105 to 95, no one says,wait a second, in the third quarter, you lost 28 to 18, what was thestory in the third quarter, before you won the game 105 to 95? SinceJeff Vinik has been running the fund it’s beaten the market and it’sbeaten 80% of all funds. That’s the game. He’s run it for four years,and that’s the game. [Days after this interview, Jeff Vinik resigned toform his own investment management company. Fidelity Magellan isnow managed by Robert Stansky, who delivered an outstanding recordfor ten years with the Fidelity Growth Fund.]
Tanous:The rap today on Magellan is that, with 56 billion dollarsunder management, beating the market is not only very difficult butit involves making major bets.
Lynch: That was true at 10 billion and 20 billion too. You can havea 100 million dollar fund and have 80 stocks exactly clone the market.You put a couple of energy stocks in, a couple of drug stocks, andothers. You can have a small fund with 80 stocks and clone themarket, or a big fund with 2,000 stocks. But people sometimes missthe point. If the airlines are one percent of the S&P 500, you mightwant nine percent in your fund. Energy is 13% of the index; but yousay we'll have zero. If you have certain things that make up the index,the index might have, say, two percent in banking, but if you lovebanking, you make it 14% of the fund. If you’re right, you beat thehell out of the index. If you’re wrong, you’re wrong.
Tanous:Isn’t that what you're being paid to do?
Lynch: That’s right. But here’s the point. The New York Stock Ex-change is, I think, close to $6 trillion [in market capitalization]. Ifyou look at the 200 largest stocks outside the U.S., you’re looking ata couple of trillion dollars. Look at NASDAQ and you're talking a
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couple of trillion. It’s not like Fidelity is $500 billion or a trillion. Allof our equity assets are, I believe, less than $300 billion.
Tanous:That’s for all of Fidelity?
Lynch: Yes. Fidelity is around $400 billion but the equity assetsare less than $300 billion, or only five percent of the New York StockExchange. So its not like we’re managing $4 trillion and the worldmarket is $8 trillion.
Tanous:As they say, it’s a nice problem to have.
Lynch: If you want to beat the market by a lot, you'll have to buya small fund and take bigger risks. But which small fund do you buy?If you went and picked one, the odds are four out of five that youwould not have done as well as Magellan.
Tanous:! see. That’s because, to bring it back to the point you justmade, Magellan beat four out of five, or 80%, of all the funds.
Lynch: Exactly. And it’s pretty much the same over time.
Tanous: You’re not managing a fund any more. I must tell you thatI loved your quote that nobody on their deathbed ever said “I wish Ihad spent more time at the office.” I’m aware of the charities you’reinvolved in and the things that interest you, but I want to know if youhave any plans to get back in the business beyond what you’re doingnow.
Lynch: No. I’m done running a fund. I did it for thirteen years. Andit was a wonderful thing. One out of every hundred Americans wasin my fund.
Tanous:One out of a hundred?
Lynch: For many of these people, $5,000 is half their assets otherthan their house. And there are people you meet who say we sent ourkids to college, or we paid off the mortgage. What I’m saying is thatit’s very rewarding to have a fund where you really made a differencein a lot of people’s lives. A lot of people manage lots of money, butif it’s for some state pension fund or for a huge company, the managerprobably has 20 customers. It’s amazing when you make a differencein a lot of peoples lives. It’s comforting and it’s a lot of responsibility,and when it works out you're very pleased.
Tanous:But now that you’re not managing a fund anymore, whatdo you do with your life?
Lynch: I used to leave for the office at 6 A.M. six days a week. Thelast ten years I ran Magellan, I got home late and traveled twelvedays a month. Now | leave for the office around eight, four or five
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days a week. I see my wife; I see my kids. I haven’t worked a Saturdayin six years. I do about two days a week of Fidelity stuff and aboutthree days a week of not-for-profit stuff. At Fidelity, | work withyoung analysts. We bring in six new ones a year and | work withthem one-on-one. | write four or five times a year for Worth magazineand I’m a trustee of the funds.
Tanous:Since you stopped managing the fund actively, have youseen anything in the markets that has changed your views about eitherthe way the market works or the value of investing in stocks over thelong term?
Lynch: Zero. Human nature hasn’t changed much in about 40,000years. Corporate profits have their ups and downs. Markets have theirups and downs. Companies turn around; companies deteriorate. Idon’t think these things are going to change in the next hundredyears.
The lingering thought you come away with after speaking with PeterLynch is how simple he makes it all sound. For generations, peoplehave spent millions of dollars devising theories and schemes to investsuccessfully. Today, quants use Cray super computers and state-of-the-art mathematics with algorithms that will unlock the key to suc-cessful investing. Peter Lynch’s alternative advice: hang out at themall. See what stores and products are doing well. Do your own re-search.
The very logic of his approach is difficult to refute. “There’s ahundred percent correlation between what happens to the companyand what happens to the stock,” he told us. That phrase sticks. Inother words, if you are successful at identifying good companies, youhave also identified good stocks. The examples he cited to back upthis theory are compelling.
Of course, for most of us, the way to invest is to pick a manageror a mutual fund and let them do the picking. After all, Peter alsostressed the importance of doing your homework. Do you have thedesire and the time to do the homework? He’s probably right whenhe suggests that most Americans do more research when buying arefrigerator than they do in buying a stock. There’s no question, logicis Peter’s long suit. Maybe he’s got the right idea. Maybe we have justovercomplicated the whole process of picking successful stock marketinvestments. Maybe a return to common sense is the best approach.It sure worked for him.
117LAURA J. SLOATE
Laura Sloate is no novice at the craft of investing. She has beenrunning her firm, Sloate, Weisman, Murray & Company since 1974.She earned her B.A. from Barnard College and an M.A. from Columbia.She is also a Chartered Financial Analyst. Although Laura has beenblind since the age of six, nothing in her schedule or work activityreflects any disadvantages she might have. In fact, she told The NewYork Timesthat nowadays, with a guide dog and some electronicequipment, it’s a level playing field.
Level or not, Laura does quite well on that playing field. Her distin-guished performance record over time earns her Guru status. She iswidely admired by her peers, and especially by her clients, for whomshe manages over $1 billion. The firm’s net annualized returns forthe five years ended in 1995 were in excess of 24% and the sevenyear returns were 20%, exceeding the S&P 500 by a considerablemargin.
Another exciting feature of her performance is that Laura’s up-market capture ratio is consistently over 100, while her down-marketratio is often negative. In plain English, she does better than themarket when the market is going up but when the market is goingdown, she either loses less than the market or actually makes moneyeven though the averages are down.
We met in Laura Sloate’s midtown Manhattan office. The office isequipped technologically to allow Laura to work unconstrained. Anelectronic voice chants the latest news off the tape and quotes can becalled up in the same manner. During our meeting, Laura shared somevery precise advice on selecting stocks and what to look for.
Tanous:How did you first get interested in stocks?
Sloate: I guess there are two parts to that question. How I got inter-ested in stocks, and then how I got interested in going into the busi-ness. My dad was an investor since the ’50s. He always had annualreports around, and every New Year's Eve, early in the evening whenthe market closed, he’d call me in and let me add up his portfolio. I'ddo it in my head and he’d do it by pencil and often I’d beat him.
Tanous:How old were you then?INVESTMENT GURUS
Sloate: Oh, ten or eleven. In those days I knew the annual reportsby how the covers felt. I lost my sight when I was six.
Tanous: You knew the reports by how the covers felt?
Sloate: Every annual [report] has a different feel. I'll give you anexample. [Laura shuffles through a stack of papers and documentson her desk and picks one up.] This here is Harrah’s annual. | remem-ber that on Friday I put the Diebold annual down here. I rememberit’s smooth...[She shuffles through some more papers and quicklypicks one report out of the stack. She hands it to me.] See. [It wasthe Diebold annual report.]
Tanous:That’s remarkable.
Sloate: And if you come back three days from now I'll do the samething. This is the Saks Fifth Avenue prospectus. I remember puttingit in here and that it was fat. [Laura “reads” in several ways. Some-times she has readers come in and record information on cassettes.More often, she scans written material into her computer which digit-izes it and, then, using special software, reads it back to her.] I'll feelone of these once and remember it forever. Here’s Business Week. Iguess I started this kind of young. That’s how I knew about stocks.
Getting back to how I got interested in the business, I went to highschool and college. In fact, the other day my brother sent me an articleabout me from the New York Journal of 1963. I was eighteen. Thearticle said that I was an intense listener, that I read 12 hours a day,and I was going to have my Ph.D. by the time I was 26. What endedup happening was that I did go to college and finished in three-and-a-half years. Then I got my master’s in six months. After that, I wentto law school for a year, and decided | didn’t like it. So I left after ayear and went to Columbia to study history. I finished my coursework and my orals for a Ph.D. in 18 months, but, by then, I was kindof burnt out academically. It was the time of the Columbia riots.
I decided I wanted to get a job. I was ill-equipped to get one becauseall my work was as an academic and | had no working skills. In thosedays, there were no computers. I read about some go-go fund managernamed Fred Mates who was going to build his firm by taking ordinarypeople who knew nothing about the market. So I went down there.He was a charitable individual; he hired me to be an analyst for hisfund.
Tanous: What was his fund?
Sloate: It was called the Mates Fund. It was one of these go-go
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stock funds of the late ’60s. I started to read things. I was living athome and [ hired a secretary to read to me. After paying her salary Iwas making, like, forty dollars a week. Mates laid me off four monthslater. The fund soon went out of business. | ran around looking forwork, and finally found somebody who hired me for $200 a week asa junior analyst in the research department. I paid $140 to my secret-ary and lived on $60 dollars a week. I started to read accounting andfinancial books and tried to learn how to pick stocks. That’s how itall started. I never went back to Columbia.
Tanous:What were you going to get your Ph.D. in?
Sloate: American History. The reason it was going to be Americanhistory is that my Master’s was in modern European. It was muchmore practical to get readers to read English than French or Italian.If you got into European history you were definitely getting intolanguages.
Instead, I got into the market and I never left. I was a researchanalyst for a rising star named Meyer Berman. Then we went over toNeuberger Berman in 1970. I was there for about a year. I went toBurnham and Company. During this period, I had 22 stock recommend-ations in a row that went up. Starting in 1973, I was pulling back onmy recommendations because I couldn’t find any stocks that werecheap enough. Management was on my case because we were paidthrough commissions. At that point, I realized that if you worked fora big firm, you would be controlled by the management. [Since Lauracould not find stocks she liked, she was unable to generate commis-sions for the firm through her recommendations. Of course, 1973 wasthe beginning of one of the worst bear markets in history, so it wasa good time not to be buying stocks.]
Tanous: What happened after that?
Sloate: [ met a fellow named Neil Weisman in 1971. We becamevery friendly. We decided we had one shot to go out and start ourown thing. We were 29 years old. So we started Sloate, Weisman in1974 as an equity research boutique.
Tanous:! want to get into your approach to investing, Laura. Yoursis a value approach. Could you describe your approach to value invest-ing and how it might differ from some other managers.
Sloate: We believe that every situation, at some point in time,presents value. In order for value to be brought out there has to be acatalyst. Sears sat with value wrapped in it for about 20 years.
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Now value, in my mind, is a mirage. If you look at many of thestatistical screens used by value managers, many of the companieslisted are bankruptcy candidates. They may look attractive relativeto book value and inventory value, but the numbers only tell one sideof the story.
We look for a catalyst to bring out the value. It could be a manage-ment change, like George Fisher leaving Motorola to go over to Kodak.Or a restructuring, like the Federated [Department Stores] managementcoming in and turning around Federated initially, then integratingthe Macy’s and Broadway Stores acquisitions - bringing the operatingmargins from the low single digits to the low double digits. Thecatalyst could also be a secular event. For instance, two or three yearsago, we invested in retail drug store stocks because we recognizedthat the delivery of prescription drugs was becoming a very importantpart of medical care.
Tanous: Was that the catalyst?
Sloate: The secular catalysts were the expansion of the prescriptiondrug benefit and the change in the delivery of prescription drugs. Thedrug stores were computerizing and preparing to deal with third partypayers, such as managed care companies. We bought Revco, Rite-Aidand Eckerd. We still own Rite-Aid.
Clinton’s proposed revitalization of the health care system was thecatalyst for the drug stocks. That knocked down drug stock prices tovaluations not seen since the early 1980s. We bought a couple ofthem. In retrospect, we sold too early, but the stocks had reached ourprice objective.
We find our ideas through fundamental research. We read a lot oftrade journals - over 100 a month. We also read 7 or 8 daily newspa-pers, company documents, and, of course, we get tons of Wall Streetresearch. In our line of work, we get two feet of material a day fromthe Street. But, the problem with Street research is its agenda. It’s in-vestment banking agenda-ed. It’s not very innovative, but it is veryinformative. We read Street research for background and to understandconsensus, because consensus is reflected in the price of the stock.
Tanous:Are you making the point that Street research might be alittle bit tinged by who the firm’s investment banking clients are?
Sloate: I would like to think it’s only a little bit. But it isn’t a littlebit. It’s a lotta bit.
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Tanous:But you also said that the research is chock full of inform-ation. So it’s not the opinion you’re looking for as much as the facts.
Sloate: Right. But you must know the facts and the opinion, andyou must know the consensus earnings estimates, because that’s whatthe broad range of portfolio managers are buying.
Tanous:Isn’t it too late then?
Sloate: Well, it may or may not be. You could have an epileptic fitevery time you miss something. You have to know what the Street issaying. But you don’t necessarily follow what they say. We use Streetresearch as an information source. Our process is much less quantit-ative than that of the traditional value manager. We get to the situ-ation conceptually. The traditional value manager looks at P/E, looksat the relationship of price to book value or cash flow. We createfinancial models to help us determine where the stock should sellbased on its valuation relative to its growth rate, its peer group, orits assets. | never look at the market because | believe I know zeroabout the market.
Tanous:Going back to your approach and process, you mentionedthat you’re not so quantitatively-oriented as other managers. As youcorrectly say, value managers are essentially quantitatively orientedbecause they look at book value, they look at assets, and other thingsthat are measurable. So I need to delve into your approach a littlemore. Presumably you look at these other factors too, but is it thecatalyst that is more important? Are there other factors in your ap-proach that are more important?
Sloate: First of all, book value today is an illusion. Between restruc-turing, write-downs, and share buybacks, book value has little value.Assets are important, particularly in manufacturing businesses, butin service companies they don’t have a great deal of importance. Thenyou get into accelerated depreciation. Are they long-lived assets orshort-lived assets? When we look at manufacturing companies, wehave begun to calculate EVA.
Tanous:What’s EVA?
Sloate: Economic Value Added. You take the average capital em-ployed and the cost of that capital. If the return on the capital invest-ment is not greater [than the cost of capital], or if it’s negative, clearlythe company is under-earning or poorly managed. That puts a damperon its value.
Tanous: When you’re looking at the cost of capital, I assume you’re
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not looking at the specific cost, but what the capital costs are gener-ally?
Sloate: Each company has a borrowing cost. So it’s the specificcost. EVA is a very hot measure now on Wall Street. It was developedby the consulting firm, Stern, Stewart, and the first place I saw it usedin financial analysis was in First Boston research. Now there areseminars on EVA. It’s becoming important in business schools. It hasa lot of validity because it includes factors that help reflect trueprofitability, such as the cost of all capital employed includingworking capital, inventories, etc., so you can’t just build inventory.It doesn’t permit companies to show positive returns and earnings ifmanagement is not meeting its capital cost hurdles.
Tanous: Your catalyst approach is especially interesting to me be-cause one of the other people I interviewed, Mario Gabelli, uses anapproach which is also very much catalyst-oriented. It’s value plusa catalyst. I find that interesting.
Sloate: Well, if you don’t have a catalyst, things will just sit around.The trucking industry hasn’t had a catalyst in years and it’s beenamong the worst performing groups in the market for two years. Webought a trucker recently. The catalyst here is restructuring, whichthey started to do, along with adding new services, but all that pro-duced was a sea of red ink. The industry is not willing to bite thebullet and restructure or downsize to drive for profitability. That’swhy we decided to sell our position.
Tanous:Laura, your returns are very impressive. Your net returnsfor the seven years ended in 1995 were 20% per year. That’s aboutfive points better than the S&P 500 in an environment where the S&P500 has been very tough to beat. What do say about this?
Sloate: I think it’s related to a couple of things. We try to have adiscipline, and we study every mistake we make. We never study avictory. If we’re right, what’s the point in studying it? It’s why Inever read about scandal. I’m never going to be a crook, so whyshould I waste my time reading about a scandal? What am I goingto learn? My view is you study your mistakes.
We have a research lunch every Friday at which we all get togetherand talk about stocks. I give a little monologue about somethingtopical. The two things I mentioned last week were the hatchet jobon Julian Robertson in Business Week and Warren Buffett’s annualletter to shareholders, which | had everybody read. [Julian Robertson
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is a renowned hedge fund manager whose performance fell on hardtimes. Warren Buffett’s annual letter to the shareholders of his com-pany, Berkshire Hathaway, is legendary.]
I said, in my opinion, here is what you can learn from the JulianRobertson story. It’s focus. Focus is the key to success. Why do WarrenBuffett and Peter Lynch [page 111] do well? Because they are focused.They have their niches and they stick to them. They may evolve themover time. Buffett writes about how his preferred stock investmentsweren't a good idea, and he discusses why. Again he’s looking at hismistakes. But it’s the focus on how the investor makes the long term,rainmaker bet on the quality management companies with a franchise.If you look at most people who have been successful, and most com-panies that have been successful, you find they’re focused, very dis-ciplined, about how they conduct business. Therefore, focus is veryimportant. Julian Robertson may have temporary problems becausehe is trying to be a global manager rather than a stock picker whenpicking stocks is what he does best.
I know I can’t play commodities or options. Somebody asked meonce, would I hedge the portfolio with some S&P puts? I said, Iwouldn’t know what to do. I wouldn’t know what the premiums meant.You could show me these programs and, to me, all these programswork until they don’t. The day they don’t work is the day you reallyneeded them. That’s what happened in 1987. Portfolio insuranceworked until the day everybody needed insurance. Then it failed. Ithink derivatives are fine for those who understand them and knowhow to work within the system.
Tanous: You say, stay with what you know.
Sloate: Right. Improve what you know, always keep improving,but stay with it. 1990 was a rough year and we learned some things.One is, don’t let your losses run.
Tanous:! was about to ask you about your sell discipline. You havesaid, basically, that if a stock goes down 15%, it’s gone. That’s gotto be controversial.
Sloate: Pll tell you what we did. We’ve modified that a little bit.We looked at fifteen stocks we sold from 1991 to 1994. The originalreason for that discipline was that if you look at individual portfolios,they generally have one or two meltdowns - stocks that collapse.What a meltdown does is divert your energy and your focus. It erodes
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your confidence and it kills your performance - wonderful character-istics! So, we try to prevent meltdowns.
In 1990, before our sell discipline was in place, | bought Broad,[named after Eli Broad], which became Sun America. It went from11 to 4 and I owned it. [That’s what inspired my decision to sell stocksthat went down 15%.] We had a fairly large position, so it really hurtour performance. It went back up and we sold it between 17 and 20.It then proceeded to go significantly higher. The bottom line is, whenwe look at our ’91 to ’94 stocks, out of fifteen stocks that we soldbecause of our sell discipline, twelve of them were higher six monthslater than where we originally bought them. And a couple were realwinners. We said, okay, this could be a timing phenomenon and wenever know. There’s no way we're going to be the perfect timers.
What we do now is, barring an October ’87 crash, or a Gulf Warkind of situation, if a stock goes down 15%, we look at it and rethinkour assumptions. We ask why it is down. We ask whether or not weshould increase the position by 50% or 100%. Maybe we don’t quitelove it as much as we did, but maybe it has gotten too cheap to sell.That’s how we’ve modified the sell discipline. We just don’t let it godown and not do anything.
Tanous:That’s a pretty drastic change of heart. Instead of sellingit you are buying more, even twice as much.
Sloate: It’s not a change of heart. It’s an evolution of process basedon a close examination of results. Statistically, we found out that in80% of the cases, if we had kept the stocks we sold six more months,we would have made money.
Tanous:But how much fundamental analysis goes into this decision?Maybe the stock went down for a reason.
Sloate: That’s right. If it goes down for a fundamental reason, it’sgone. We look at all the fundamentals. We call the company; we redoour earnings models. We go through the whole process all over again.We decide yes or no.
When these things are on the bottom, you wish you never ownedthem. You kind of hate them. It’s like a kid who’s had a temper tan-trum. You’ve had enough. I look at my portfolio as little puppy dogs.Some days they’re well, some days they’re sick,