Peter Lynch: Cocktail Theory

by Manshu on August 27, 2009

in Opinion

Peter Lynch has been one of the most successful investors and fund managers of all times and his book: ONE UP ON WALL STREET is a terrific and delightful book. Not only is the book a fine example of the wit, experience and knowledge; it is an easy read, and you can breeze through it.

Anyone who is serious about investing and can spare the cash must read it. This post discusses one delightful theory that Peter Lynch discusses, and I am sure if we look hard enough we can find similar examples from our daily life and relate to what he is saying.

Lynch calls it “The Cocktail Theory”. This theory is developed by Lynch for forecasting markets and has done so by standing in the middle of living rooms listening to what people have to say. In the first stage of an upward market where the market has been down for some time and no one expects it to rise again people are generally not talking about the markets. When someone asks Lynch what he does for a living and he tells them that he manages a fund they nod politely and move away to talk to the dentist about plaque.

Lynch says that if people would much rather talk to the dentist about plaque than to a fund manager about stock it is likely that the market is going to go up.

In stage two, when the market has risen about 15%, but still only a very few people have noticed it, the new acquaintances linger a bit longer with Lynch telling him how risky the market is before moving away to the dentist to discuss plaque.

In stage three with the market up 30%, Lynch says that he is surrounded by enthusiastic investors asking for tips, and even the dentist is looking for some tips from him, and everyone has their money invested at one place or the other.

In stage four Lynch is surrounded again, but this time people are not asking him what to buy, they are telling him what to buy!

The dentist has a tip or two of his own too, and in the next few days it’s likely that the dentist’s recommendation goes up.

This Lynch says is a sure sign that the market has reached the top, and is due for a tumble.

Lynch issues a caveat at the end of the theory saying that the key to investing is to buy great companies and not predicting markets.

In fact he categorically states that he does not believe in predicting the markets. Each one of us who has stayed in the market to witness at least one cycle would find a similar example to what Lynch gives and would easily relate to what he says.

In fact, I think currently we are in stage 2 of the theory because people have started talking about stocks again, no one is unduly enthusiastic, but they sure are talking.

{ 3 comments… read them below or add one }

Vikrant April 7, 2010 at 1:43 am

Superb.. Very nicely put, i must buy this book and read. Thank you for sharing.


Manshu April 9, 2010 at 2:23 pm

Yeah, this is a great book – I am sure you will find it worth your time.


Sridhar April 30, 2010 at 3:06 am

I read this book by Peter Lynch several years ago. This article was a nice reminder about it.


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