The legendary Peter Lynch made famous the "buy what you know" investing philosophy, delighting Fidelity Magellan shareholders with near 30% annual returns in the 1970s. For example, after his wife, Carolyn, mentioned how great Hanes' L'eggs pantyhose were, he did his research and bought into the company (now known as Hanesbrands
However, Lynch also had another genius quirk: his love for obscure, boring companies. Here's why grasping this concept can be extremely profitable.
Under the radar
Investing in obscure stocks may seem counterintuitive at first, but that's entirely understandable. After all, it's obvious that the real money is being made in big names like Peabody Energy
Wouldn't it be better to find the companies whose great runs are still to come?
That's where the obscure and boring part comes in. We're much more likely to unearth a future Lynch 10-bagger among the names that are not yet household, but will be in a few years. It's not a bad thing if your friends remark, "You bought what?" when hearing of your latest investment.
Lynch, for example, raised a few eyebrows with his purchase of Pep Boys. Many had never heard of the auto-parts store and found the name rather silly. That was fine by Lynch, because it allowed him to get into the stock at bargain prices. Hansen Natural is another example of a company that was all but ignored in its early days. Yet the combination of great natural drinks and superior marketing has led to outstanding returns over the years: A $5,000 investment in the stock even a couple of years ago would have turned into $100,000 today.
More examples can be found in some of Tom Gardner's Motley Fool Stock Advisor recommendations. Have you ever heard of Amerigroup
Boring. Obscure. But Tom recommended them to members about two years ago, and they've beaten the market since.
You can see how unknown companies are more likely to carry bargain price tags than their headline-grabbing brethren. Because fewer people have heard of them, there's less demand for their stocks. Lower demand, lower prices.
But the best part is that as long as a company executes well and continues to rake in the cash, it will attract greater notice. It can't be helped. More investors begin to buy in, driving up demand right along with the stock price.
Tom and his brother David have employed several Peter Lynch principles on their way to outstanding performance in Stock Advisor -- 69% total average returns vs. 30% for equal amounts invested in the S&P 500. You can get a look at their two new picks, plus all their past recommendations, free of charge with a 30-day trial. There's no obligation to subscribe.
This article was originally published on Feb. 17, 2006. It has been updated.
Rex Moore is a below-average bocce player and owns shares in no companies mentioned in this article. Sara Lee is a former Income Investor recommendation. The Motley Fool has a disclosure policy on that Internet thingie.