The L'eggs Legacy

In 1982, Peter Lynch's keen observation of his wife's shopping habits led to one of the most profitable investments in Fidelity Magellan Fund's history. The Hanes Company, particularly its L'eggs brand, became a cornerstone of Lynch's portfolio, exemplifying Philip Fisher's wisdom about the enormous potential of the right companies.

Lynch's initial interest was piqued by a simple act: his wife purchasing L'eggs pantyhose at a supermarket. This seemingly mundane event set off a chain of analytical thinking in Lynch's mind:

1. Market Penetration: Lynch realized that L'eggs had achieved something revolutionary - bringing department store quality hosiery to supermarkets and drugstores. He calculated that the average woman visited these stores weekly, compared to department stores every six weeks. This 6x increase in purchase opportunities was a game-changer.

2. Distribution Innovation: The unique egg-shaped packaging wasn't just a gimmick. It allowed L'eggs to be displayed on countertops and in standalone racks, maximizing visibility in non-traditional retail spaces. Lynch estimated this could increase sales per square foot by 30-40% compared to traditional packaging.

3. Brand Dominance: Through store visits and interviews, Lynch discovered that L'eggs commanded a staggering 85% market share in food and drug outlets. This dominance suggested significant pricing power and economies of scale.

4. Financial Analysis: Digging into Hanes' financials, Lynch found:

- Revenue growth averaging 25% annually over the past 5 years

- Profit margins expanding from 8% to 12% due to scale efficiencies

- Return on Equity (ROE) of 28%, well above the industry average of 15%

5. Valuation: Despite these strong fundamentals, Hanes was trading at a P/E ratio of 10, below the market average of 15. Lynch calculated that if earnings continued to grow at 20% annually (a conservative estimate given recent performance), the stock could double in 3-4 years even without P/E expansion.

Lynch's deep dive didn't stop there. He investigated potential risks:

1. Fashion Risk: Through consumer surveys, he found that pantyhose was viewed as a staple, not a fashion item, mitigating cyclical risk.

2. Competition: Interviews with retailers revealed high switching costs due to L'eggs' custom displays, creating a barrier to entry for competitors.

3. Raw Material Costs: Lynch studied nylon price trends and Hanes' supplier contracts, concluding that the company had sufficient pricing power to offset potential cost increases.

Based on this comprehensive analysis, Lynch initiated a position in Hanes, eventually building it to 2% of the Magellan Fund's portfolio - approximately $280 million at its peak.

The results were spectacular. Over the next five years:

- Hanes' stock price increased by 450%

- Earnings grew at an annualized rate of 31%

- The P/E ratio expanded to 20, reflecting the market's recognition of the company's quality

By 1987, Lynch's initial investment had grown to over $1 billion, contributing significantly to Magellan's outperformance.

This case study illustrates several key aspects of Lynch's investment philosophy:

1. The power of observational research: A simple shopping trip led to a billion-dollar idea.

2. The importance of understanding consumer behavior: Lynch's insights into shopping patterns were crucial.

3. The value of thorough, multi-faceted analysis: From store visits to financial statement analysis, Lynch left no stone unturned.

4. The patience to let a good investment grow: Lynch held onto Hanes for years, allowing compounding to work its magic.

In the end, the Hanes investment wasn't just about buying a good stock; it was about recognizing a great business and having the conviction to invest heavily in it. This approach, rooted in Fisher's philosophy, turned a humble pantyhose maker into one of the most successful investments in mutual fund history.