Peter Lynch is one of the most successful investors of all time, achieving a remarkable 29.2% annualized return over a 13-year period from 1977 through 1990 at the helm of Fidelity's Magellan Fund.
Not only did Lynch build an excellent track record of market-beating performance, but he did it using many techniques that anyone can learn. And he's been eager to share his wisdom with everyday investors like you and me through timeless classics like One Up on Wall Street, Beating the Street, and Learn to Earn. Whether you're a new or seasoned investor, I strongly suggest picking up copies of all three.
With that, here are three of the best investment lessons I've learned from Peter Lynch, and how I've applied them (successfully) to my own strategy. These are just a few out of hundreds of valuable lessons you can learn from Lynch's books, but they are the three that stand out the most in my mind.
Lesson 1: Use what you know to get an edge
The general theme of Lynch's most famous book, One Up on Wall Street, is that everyday investors actually have some key advantages over professionals. One of them is the power of observation. In other words, consumers can spot trends that don't fully show up in quarterly reports or in analysts' calculations.
Applying this principle in my own investment strategy produced my single greatest investment return (so far). Here's the condensed version of the story:
My wife and I go to a local craft/artisan market every Saturday with our kids. We take our dog with us and shop for unique things to put in our house and have lunch at one of several excellent food trucks that frequent the market.
Typically, on the way to the market, I would stop by the ATM and take out some cash to cover our lunch and various purchases. However, in early 2016, I started to notice a trend. Each time I went to the market, I needed to use cash less. More and more vendors had tiny, white card readers attached to their smartphones, allowing me to pay with a credit card for traditionally cash-only types of items.
At the time, Square (NYSE: SQ) had recently completed its IPO and its stock wasn't doing too hot. Most Wall Street insiders saw it as a niche manufacturer of payment-processing hardware that would never achieve widespread adoption. However, I could see with my own eyes that they were wrong. A few weeks after I noticed the trend, I did a bit of research on the company, and bought some shares for $11 each.
Fast-forward a few years and Square has leveraged its popularity into a growing financial ecosystem. Even after poor performance in late 2018, Square trades for more than six times what I paid for it less than three years ago.
Lesson 2: You can diversify and beat the market
One common misconception among investors is that if you own more than a dozen or so stock positions, it's extremely difficult to beat the market. After all, to generate truly impressive returns, don't you need to put a large percentage of your capital into just a few investment vehicles?
It might surprise you to learn that Lynch achieved his near-30% annualized returns without an ultra-concentrated portfolio. In fact, there were times during his incredible 13-year run when the Magellan Fund had more than 1,000 individual stocks in its portfolio.
The way Lynch saw it, if a stock had a good chance at outsized returns, it belonged in the portfolio. However, he only invested in what he perceived as the best stocks at any given time -- sector diversification was not a primary concern. In other words, if Lynch thought a particular sector was generally overpriced, he had no problem with being very underweight.
I've used this principle as well, with success. As of this moment, I own more than 30 individual stocks, and more than 50% of my portfolio is made up of REITs, banks, or insurance companies. Not only do I understand them well, but I feel they offer the best opportunities. Notably absent or under-represented in my portfolio are industries I don't understand well or don't see as much potential in -- healthcare, utilities, and retail are three examples I can think of right off the top of my head.
Lesson 3: Do your homework
While One Up on Wall Street is perhaps Lynch's best-known book, my personal favorite is Learn to Earn. In a nutshell, this book is an overview of basic business and investing concepts, such as how to read stock quotes and company reports. In my opinion, it should be required reading for every college freshman in the United States. It's that good.
As Lynch has said, "behind every stock is a company. Find out what it's doing." In other words, it's important to do your homework when you invest, and it's equally important to make sure you know how to properly do your homework.
This is especially important when it comes to evaluating stocks that aren't well-covered by Wall Street analysts. Lynch believed that it's far more common for smaller companies to be mispriced than larger ones, and by learning to properly assess smaller companies, I can confirm that this is true. In fact, some of my best investment gains have come from small-cap stocks.
Happy birthday to one of my all-time favorite investors
With that, I'd like to say thank you to Peter Lynch for his contributions to my investment knowledge and to wish him many happy returns. And, if you're reading this and aren't too familiar with Lynch or his lessons, do yourself a favor and pick up one or all of his timeless investment classics. You'll be glad you did.
Matthew Frankel, CFP owns shares of Square. The Motley Fool owns shares of and recommends Square. The Motley Fool has the following options: short January 2019 $80 calls on Square. The Motley Fool has a disclosure policy.