The Walmart Windfall

Back in 1977, when Lynch took the helm of the Magellan Fund, Walmart was far from the retail behemoth we know today. It was a regional discount store chain with just 190 stores across the southern United States. Most Wall Street analysts overlooked the company, dismissing it as a small-town operation with limited growth potential. But Lynch saw something different - he saw earnings.

Lynch's interest in Walmart wasn't sparked by a fancy presentation or a hot tip from an industry insider. It was ignited by something far more mundane: a family shopping trip. During a vacation in Tennessee, Lynch's wife, Carolyn, dragged him into a Walmart store. As he wandered the aisles, Lynch was struck by the bustling activity and the store's efficient layout. But it wasn't until he dug into the company's financials that he truly became excited.

What Lynch found was a company with a consistent track record of earnings growth. From 1970 to 1977, Walmart's earnings per share had grown at an impressive annual rate of 40%. This wasn't a one-time fluke or the result of financial engineering. It was the product of a well-oiled machine that was steadily expanding its reach and improving its operations.

Lynch's decision to invest in Walmart wasn't based on a hunch or a complex financial model. It was rooted in a deep understanding of the company's earnings power. He looked at Walmart's price-to-earnings ratio, which was around 20 at the time, and compared it to the company's growth rate. This simple calculation - what Lynch called the PEG ratio (price-to-earnings ratio divided by growth rate) - suggested that Walmart was undervalued.

But Lynch didn't stop there. He dug deeper into the drivers of Walmart's earnings growth. He studied the company's expansion plans, its inventory management system, and its cost-cutting initiatives. He even visited Walmart's headquarters in Bentonville, Arkansas, to meet with management and get a firsthand look at the company's operations.

What Lynch found was a company with a clear path to continued earnings growth. Walmart had perfected a formula for opening new stores in small towns, where competition was limited and real estate was cheap. The company's efficient distribution system allowed it to keep costs low and pass savings on to customers, driving higher sales volumes and better profit margins.

Lynch's focus on earnings led him to make Walmart one of the largest positions in the Magellan Fund. From 1977 to 1990, the period of Lynch's tenure, Walmart's stock price increased by more than 1,100%. This wasn't just a lucky break - it was the result of consistent earnings growth that averaged over 35% annually during this period.

The Walmart case illustrates the profound wisdom in Lynch's advice to focus on earnings. Earnings are the lifeblood of a company, the tangible evidence of its ability to generate profit from its operations. While other metrics can be manipulated or misinterpreted, earnings provide a clear picture of a company's financial health and growth potential.

Lynch's approach to Walmart demonstrates the power of combining quantitative analysis (studying the earnings numbers) with qualitative research (visiting stores, meeting management). This holistic approach allowed him to see beyond the surface-level financials and understand the underlying drivers of Walmart's earnings growth.

Moreover, Lynch's Walmart investment showcases the importance of patience and long-term thinking in investing. He didn't try to time the market or make quick profits. Instead, he held onto Walmart for years, allowing the power of compounding to work its magic as the company's earnings continued to grow.

The Walmart case also highlights the value of looking beyond Wall Street's radar. While many analysts were focused on larger, more established companies, Lynch found a gem in a relatively unknown regional retailer. This underscores another of Lynch's famous pieces of advice: invest in what you know. His personal experience as a Walmart customer gave him insights that many Wall Street analysts lacked.

In the end, Lynch's focus on earnings paid off handsomely. His investment in Walmart contributed significantly to the Magellan Fund's spectacular performance under his management, with the fund growing from $20 million to $14 billion in assets.

Don't get distracted by flashy metrics or complex financial models. Instead, focus on the fundamentals - particularly earnings. After all, as Lynch's Walmart investment proves, sometimes the path to extraordinary returns is paved with simple wisdom and a keen eye for earnings growth.