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3 Stocks Peter Lynch Would Love

By Brian Withers - Jan 19, 2020 at 12:28PM

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Investing legend Peter Lynch laid out an approach with which novice investors could beat Wall Street professionals.

Peter Lynch was the portfolio manager for the Fidelity Magellan Fund from 1977 to 1990, when it more than doubled the return of the S&P 500. But the great track record on stock trading may not be why many investors study his advice.

Lynch wrote two books that made investing accessible to the individual investor: One Up on Wall Street and Beating the Street. These texts laid out an approach where novice investors with an eye for quality, investing in businesses they understand and holding for the long term, could achieve better returns than the Wall Street professionals. His style and approach are emulated by many successful traders today.

Based on his approach to investing, here are three Lynch-style stocks that may deserve a place in your portfolio: Starbucks (SBUX 0.04%), Costco Wholesale (COST 3.13%), and Stitch Fix (SFIX 1.08%)

Man looking relaxed in a brightly lit office with a coffee, his feet on the desk, and a smile.

Image source: Getty Images.

1. Starbucks: Quality businesses win over time

Starbucks is synonymous with great coffee. But just selling caffeinated beverages isn't what propelled this retail giant to grow to be a business with a $26.5 billion annual revenue run rate. It was also the focus on the customer experience. In the early days, former CEO Howard Schultz characterized its stores as being the "third place" where people would spend time (after home and work). Baristas and order takers would learn your name and remake any drink that wasn't perfect, no questions asked. Stores had comfortable chairs and were laid out to make it easy to meet friends to spend time socializing.

Customers loved the experience and the coffee, which gave the chain pricing power (the ability to raise prices and not lose customers) and enabled it to create a solid business model. The financials allowed the company to continue to invest in its growth and its employees, and the rest is history. The stock has grown over 690% over the last decade, and with China and digital as major growth engines going forward, it will continue to grow for many years to come.

2. Costco: Invest in what you know

"Investing in what you know" is one of the most oft-quoted points of a Lynch-style stock, but just being a customer isn't enough. Knowing a business and how it makes money was a cornerstone of Lynch's process. For those who take a little time to observe the process at one of Costco's warehouse stores and read its annual report, the levers of its business are pretty obvious. 

First, it keeps costs low and passes those savings on to customers. You don't have to be a rocket scientist to see this in action. Stores are no-frills: products are on pallets to minimize stocking costs, items are in large package sizes to maximize value, concrete floors make maintenance a breeze, and there aren't any bags at checkout. Rotating items in stock creates a "treasure hunt" experience that keeps people coming back. A quick look at the financials shows that the customers' annual membership fees are what drive the profits and confirm the winning formula that this warehouse store has created. 

The over 400% return in the stock over the past decade (plus a dividend!) is proof that its business model rewards shareholders. Its continued top- and bottom-line growth makes this "invest in what you know" stock a buy.

3. Stitch Fix: Holding for the long term

Lynch knew that a growth story could take as long as "three to ten years to play out" to become a big winner. Stitch Fix is still in its early days and could be the kind of game-changing business that investors would want to own over the long term. 

The company has changed the way its customers shop for clothes. Instead of heading to a retail store and spending a lot of time trying on things that may or may not fit, clients log in to their online accounts and request a "fix." A personal stylist uses the power of data science and any input from the client to create a set of five items (a fix) that are sent to the client's home to try on. Clients only pay for what they keep (getting credit for the styling fee) and can return any or all the items. Customers love the experience and convenience.

It's playing off several trends that are still in the early innings: e-commerce and buying clothes with the help of a personalized consultant. With e-commerce, you might be surprised to find out that the data shows that only 10.5% of U.S. retail sales in the third quarter came from online. In the past, having a personalized stylist has been an exclusive perk only for the rich, but Stitch Fix is changing that, and it's catching on.

Stitch Fix grew its active clients almost 17% last quarter to 3.4 million, and those clients are spending more, accounting for 21.5% topline growth. Its new offerings, Shop Your Looks and Shop New Colors, are gaining traction and are expected to be meaningful growth drivers as they become available to all its clients. The company's founder and CEO, Katrina Lake, has a long-term vision for the company and is making smart moves to position it to be a much bigger business five and 10 years from now.

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Stocks Mentioned

Starbucks Corporation Stock Quote
Starbucks Corporation
SBUX
$73.42 (0.04%) $0.03
Costco Wholesale Corporation Stock Quote
Costco Wholesale Corporation
COST
$429.48 (3.13%) $13.05
StitchFix Stock Quote
StitchFix
SFIX
$8.39 (1.08%) $0.09

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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