Why Peter Lynch-Style Investing Keeps Getting Harder

Read Peter Lynch's books and you come across the story of him tasting a sandwich at a franchise sandwich shop he happened to drop into, then going over the financial statements and discovering the company was undervalued. Lynch's books are mostly set in the 1980s, and at the time financial techniques were not well developed, so family offices and private equity funds had not developed Leveraged Buyout. Rather than raising enough capital to acquire a company outright, finance mainly found its meaning in brokerage fees.

Passing through the Dot-com Bubble and the The Subprime Mortgage Crisis, the abundant liquidity created in the market and the sophistication of finance let private equity and Hedge Fund raise huge leverage, and it became common for them to buy a company, take it private voluntarily, maximize its value and sell it.

The vice chairman of MBK Partners frames this as finance moving from the role of intermediary to becoming the party that runs companies directly. There is a lot of noise in that process. Look at Korea's McDonald's and Homeplus alone: they install a chief executive who can massage the Balance Sheet and then go after cost cutting that maximizes the company's profit by riding on the brand value built up so far.

Because consumers' buying patterns do not change right away, profits look very good in the short run when cost cutting is pushed to the maximum.

Back to the main point: companies that are simply too good, especially ones selling below book value, have become much harder to find since Great Recession. If anything, you should be careful when a company you are buying has an absurdly low Price-to-Book Ratio. Columbia Business School is said to teach that when PBR is absurdly low, the chance the market is wrong is around 12%. Of course this assumes financial firms are well developed, accounting is strict, governance is sound, and the Price-to-Book Ratio is nonetheless low.