By John Reeves | September 17, 2012
In the lead-up to Sept. 25's Worldwide Invest Better Day, The Motley Fool is reacquainting investors with the basic building blocks of investing. In light of that, who better to consider than one of the most Foolish investors of all?
Peter Lynch put together one of the greatest investing track records of all time, while serving as the portfolio manager of Fidelity's Magellan Fund. An ordinary investor who put $1,000 in the fund on the day Lynch took over would have had roughly $28,000 by the time Lynch stepped down 13 years later.
Despite those truly remarkable returns, Lynch was a passionate believer in the notion that the normal investor can pick stocks better than the average Wall Street professional. In fact, he argued that the retail investor had numerous advantages that might allow him or her to outperform both the experts and the market in general.
Lynch did not say, however, that it would be easy for retail investors to outperform. He believed they could do the job very well, but that they had to do certain things. Below are three simple lessons from Lynch that will assist ordinary investors in their quest to beat the market:
1. Do the work. Peter Lynch is very well known, of course, for recommending that investors "buy what they know." According to this principle, investors may want to invest in that busy restaurant on the corner that always seems crowded on Friday night.
Perhaps less well-known about Lynch is that he expected investors to understand their businesses before putting their money in them. In his classic book One Up On Wall Street, he recommended that you should "never invest in any company before you've done the homework on the company's earnings prospects, financial condition, competitive position, plans for expansion, and so forth."
Amazon.com (Nasdaq - AMZN) provides a great example here, I think. Many of us are dedicated users of the online retailer, so why wouldn't we want to invest our money in the company as well? Before doing so, however, investors might want to know why the company's profit margins are so low, and how the company intends to increase those margins over time. Finally, investors should feel comfortable with Amazon's valuation too before buying shares in it.
Lynch was an indefatigable worker himself, who felt that -- borrowing from Edison – "investing is ninety-nine percent perspiration." In general, he believed that you need to "know what you own" and just thinking it will go up "doesn't count." As a result of this belief, Lynch figured that a part-time stock picker probably only has time to follow eight to 12 companies. And he warned that "if you don't study any companies, you have the same success buying stocks as you do in a poker game if you bet without looking at your cards."
2. Use your edge. Lynch strongly believed that everyone has an edge that can allow them to outperform the experts. The key is to utilize your edge by investing in companies or industries that you understand well.
He recommended that individuals identify three to five companies that they could know very well. You could study them; lecture on them; and understand their stories intimately. Ultimately, Lynch felt that ordinary folks need to discover their personal edge, whether it's a profession or hobby or even something else, like being a parent.
When I started out as an investor, Procter & Gamble (NYSE - PG) was a stock I felt I had a considerable edge with. My grandfather had worked for the company for over 30 years, and my grandmother held quite a few shares of the company. As a kid, I always talked with her about new products and challenges facing the business. When I first began buying stocks, I always felt extremely comfortable having P&G in my portfolio. Each of us probably knows a company or two like that, and we must use that edge to our advantage.
3. Be patient. Being patient and investing for the long term should be the simplest investing lesson of all. Sadly, it's one of those things that is easier said than done. In 1960, the average holding period for a stock was eight years; nowadays, it's just four months.
Lynch often said that he had no idea what the market would do in one or two years. But he was confident about what stocks would do 10, 20, or 30 years from now. He truly believed that time was on the side of the retail investor, and that's why he was an enthusiastic proponent of long-term investing.
And yes, he was aware of some long time frames where the market didn't do well. In an interview with Frontline, he referred to the period from 1966 to 1982 when the market was flat for the most part. But Lynch noted that you'd have still received dividends from your stocks. He also felt that corporate profits tend to trend upward, and that investors would eventually be rewarded for that.
McDonald's (NYSE - MCD) is perhaps a good illustration of a stock that will outperform today's market. Over the past decade, the S&P 500 has been more or less flat. Going forward, however, McDonald's -- with its growing dividend and overseas expansion -- is likely to perform very well for long-term investors. Similarly, I'd be very surprised if ExxonMobil (NYSE - XOM) -- with its growing dividend and rock-solid balance sheet -- didn't do well over the next decade regardless of the performance of the overall market.
Lynch believed that it "pays to be patient, and to own successful companies." He understood that there are times when there doesn't appear to be a correlation between a company's operations and its stock price. Lynch also knew, however, that "in the long term, there is a 100 percent correlation between the success of the company and the success of its stock. This … is the key to making money."
Simple is as simple does
Peter Lynch once said, "The simpler it is, the better I like it." In a world of faster trading and ever-increasing flows of information, keeping it simple might be the ultimate edge for the ordinary investor. Always remember, though, that simple doesn't necessarily mean easy. I know I have to work a lot harder on all three of those "simple" lessons mentioned above.
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