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Peter Lynch
Between 1977 and 1990, as manager of Fidelity’s Magellan Fund, Peter Lynch’s investments yielded an annualized return of 29.9 percent while the general market rose 16.5 percent. This performance made a celebrity of Lynch.
Of course, the fact that Lynch has authored several books and articles explaining his success helps. If you have a superb investing record, and you can explain it in an engaging manner, there is a high likelihood you will become a star of the investing world.
Peter Lynch’s basic philosophy – which Lynch acknowledges may be perilous for the unwary – is to invest in what you know. He explained his methods in two well-known investing books – One Up on Wall Street and Beating the Street.
Lynch says he found many of his best stock picks when he was out with his family, or making a purchase at a supermarket or mall. He believes most small investors should be able to enjoy success by keeping their eyes and ears open as they go about their normal day-to-day business.
The reason, according to Lynch, that smart small investors should be able to beat the street, is that they are not bound up by the investing rules adopted by most mutual and investment funds.
In One Up on Wall Street Lynch says the problem with fund-managers is that too few of them are willing to move off an already well-worn path. The unwritten rule is “you’ll never lose your job losing your client’s money in IBM”.
The vast majority of fund-managers select their stock-picks from an “approved stock list”. Before a stock can be approved it must be well known and covered by a large number of stock analysts. This results in what Lynch describes as “Street Lag” in which the big funds only identify stocks after more astute, flexible investors are already sitting on healthy gains.
In contrast to a typical fund-manager, Lynch’s ideal stock would have little or no institutional ownership. If institutions have been buying, a stock may already be too expensive to provide the returns Lynch is now famous for. Lynch likes to buy stocks before their products or services have become well-known nationally – the best growth will be obtained with small-cap stocks that have room to grow into medium or large-cap stocks.
Lynch says, “If you stay alert, you can pick spectacular performers out of the neighborhood shopping mall long before Wall Street discovers them”.
For example, Lynch says that after his wife enthused over Hanes selling its L’eggs pantyhose in grocery stores – unusual at the time – he reckoned Hanes was going places. He was right. Hanes became a six-bagger for Lynch.
In case you don’t know what a six-bagger is, Lynch himself introduced the “bagger” into investing-jargon. A six-bagger is a stock which grows six times in value – from $1 to $6 or from $2.50 to $15, etc. Similarly, a ten-bagger is a stock which grows in value by a factor of 10.
I have already mentioned that Lynch’s basic philosophy of buying what you know could be dangerous for the unwary. The danger lies in believing that a company will be a good investment simply because you like what they do. A company might have a fantastic service or product but that does not necessarily mean its shares are going to be worth more in five years time than they are now.
For example, Warren Buffett’s purchase of Coca Cola shares in 1987 made him a lot of money. A lot of smaller investors followed Buffett’s lead. In 1998, helped by small investors’ share-purchases, Coca Cola shares peaked at almost $89. Eight years on, they’re tracking between $40 and $45. Coca Cola is still a great product and it’s selling in greater quantities, in more markets now than it did in 1998. Investors have been disappointed though.
So, in addition to identifying great products or services, investors who wish to follow Lynch’s methods need to be able to tell whether a company’s shares are selling at an attractive price. Lynch would assess whether this is so by using fundamental analysis.
To follow in Lynch’s footsteps, therefore, it is vital to have a thorough understanding of fundamental analysis of stocks.