Peter Lynch's Principles

A favorite book offers a Drip investor some straightforward messages that will help you keep your investments and your life in perspective.

Motley Fool Staff
Motley Fool Staff
Jun 29, 2000 at 12:00AM

We've been talking a bit on the Drip Investing board about books on investing principles and practices. A favorite of mine has always been Peter Lynch's Beating the Street, published in 1993. For over 20 years, Lynch was at the helm of Fidelity's flagship Magellan Fund, where he amassed one of the best performance records ever.

Peter's message is a Foolish one — you, an individual, can actually find great stocks before Wall Street does. He shows how you can be an expert in a company and how the products and services you use and enjoy are often provided by excellent companies. With research in these companies, you have an outstanding chance at compounding market-beating returns.

What stood out in my mind as I flipped through the pages of this intriguing volume were the 21 "Peter's Principles" sprinkled throughout the chapters. These Foolish caveats serve as beacons, helping to keep things in perspective with investment philosophies, as well as life. Let's take a closer look at Peter's rules of the road.

1. "When the operas outnumber the football games three to zero, you know there is something wrong with your life."

It's very easy to get caught up in life's pursuits and to forget about life in general. Peter was working so hard at dominating the fund industry, he had lost sight of the things that are truly important to him: family, friends, and leisure. In roughly a two-year period, he had failed to read a single book or watch a football game. We must remind ourselves to focus not only on our goals and careers, but also on enjoying our lives.

2. "Gentlemen who prefer bonds don't know what they're missing."

Out of the past eight decades, stocks, as measured by the S&P 500, have failed to outperform bonds in only one, the 1930s. In the following decade, stocks more than tripled the return of corporate bonds, more than making up for the one losing season. Since no one could ever consistently predict when bonds may again win a decade, it's virtually a given that long-term investors should be in stocks.

3. "Never invest in any idea you cannot illustrate with a crayon."

I think I take from this a slightly different meaning than intended by Mr. Lynch. Rather than investing only in simple, easy-to-understand businesses, I think one ought to be able to paint a picture of the both the importance of the business and why it will succeed. If you don't have a good understanding of why the company will thrive, you likely will not recognize signs that it may begin to fail.

4. "You can't see the future through a rearview mirror."

History will not repeat itself exactly. There may be trends that are repeated and some coincidences may occur, but depending on a reproduction of the past will most likely be disastrous. Use the past for what it is — a track record, not a road map.

5. "There's no point in paying Yo-Yo Ma to play a radio."

Peter was speaking of bonds with up-front sales charges (loads) compared to no-load funds, both of which return about the same. Remember the Dire Straights song "Money for Nothing"? I think we can take this a giant step forward and realize that paying for any service relating to investing must provide superior returns to its inexpensive or free alternatives. Whether it's a Drip fee, commission, or a financial advisor's fee, be sure that you're getting superior value for your hard-earned money.

6. "As long as you're picking a fund, you might as well pick a good one."

With all due respect to fine fund managers such as Peter Lynch, the best fund for my money would be an S&P 500 Index fund. Since the S&P 500 traditionally outperforms 70-90% of managed mutual funds annually, there's very little evidence to support a move outside of this fund.

7. "The extravagance of any corporate office is directly proportional to management's reluctance toward shareholders."

Fiscal responsibility goes beyond business management. It also applies to glossy quarterly reports, lavish offices, and other unnecessary expenses. One company that I Drip, Harley-Davidson (NYSE: HDI), earns my applause for keeping its Drip expense low by issuing quarterly statements rather than monthly. It also minimizes the flash and fluff in its quarterly financial reports. These things may seem insignificant at first, but when you consider the number of these documents produced each year, the savings are considerable.

8. "When yields on long-term government bonds exceed the dividend yield of the S&P 500 by 6 percent or more, sell your stocks and buy bonds."

OK, I don't agree with this one. All things considered, I believe you'll find that riding out these periods of time fully invested in our nation's elite businesses will reward investors much more handsomely in the long haul.

9. "Not all common stocks are equally common."

I'll spin my own interpretation for number nine. The greatest advantage we have as individual investors is that we have the power of choice. We can choose the industries that we invest in, the number of companies we hold, and we can choose the very best of the whole heap. Reward yourself by owning the absolute king-of-the-hill, brand-rich, cash-generating companies available. You have a choice. Why settle for less than the best?

10. "Never look back when you're driving on the autobahn."

To be honest, the meaning of this one escapes me. How about we open it up to interpretation on the Drip discussion board. The poster who best convinces me of the relevance of number 10 to Foolish investing will win a Fool ballcap or T-shirt. We'll run the contest over the next two weeks and announce the winner here on July 13.

We'll continue with Peter's Principles next Thursday. Drip on, Fools!

— Vince Hanks, TMF Elwood on the Fool discussion boards