3 Lessons From Lynch

Many Fools are familiar with Peter Lynch's wonderful book, One Up on Wall Street. Entertaining, informative, and full of common sense, it unveils many of the secrets Lynch used to rack up enormous gains for his Fidelity Magellan shareholders in the 1970s.

It's also the first book Tom Gardner recommends to his Hidden Gems members as they further their investing knowledge and seek to complete his "Grand Masters" reading list. Today, I'll draw on three simple Lynch lessons from the book that can be extremely powerful as you attempt to supercharge your portfolio.

1. It's not as hard as it seems
In the never-ending debate over who should be handling your money -- you or a professional -- Lynch comes down squarely on your side. "Twenty years in this business," he writes, "convinces me that any normal person using the customary three percent of the brain can pick stocks just as well, if not better, than the average Wall Street expert."

Lynch never implies that it's as easy as investing in the companies whose products you use. But the "buy what you know" philosophy can work, if you recognize your strengths and stay alert to all that's happening around you as you shop, as you work, and as you play. You know what's good and bad, what sells and what doesn't, he says -- and "you know it before Wall Street knows it."

2. Those wonderful 10-baggers
Finding one or two 10-baggers -- stocks that increase 10 times in value -- in your lifetime is all you need. Here's an actual example from the book that shows the effect a 10-bagger can have on your portfolio. The returns cited below are from Dec. 22, 1980, to Oct. 4, 1983.

Without Stop & Shop, this portfolio over the nearly three-year period turned $10,000 into only $13,040, according to Lynch's recount. But with Stop & Shop, the money more than doubled to $21,060 -- a total return of 110.6%.

"The more right you are about any one stock," says Lynch, "the more wrong you can be on all the others and still triumph as an investor."

3. To be right, think small
Here's a revelation: The best way to invest in a future 10-bagger is to get in before it 10-bags! In the book, Lynch cites the classic example of a husband with his nose in TheWall Street Journal looking for the next hot tip. He barely listens as his wife comes home from a shopping trip, gushing over a wonderful new women's apparel store called The Limited. Great clothes, great prices, and the place is full of customers, she says. The husband, meanwhile, invests in an industry he doesn't understand, losing half his money.

The Limited expands to 400 stores across the country, and its stock price rises from a split-adjusted $0.50 to more than $52 in just eight years. After reading several favorable magazine articles, the husband tells the wife he has invested in that store she raved about several years ago. Predictably, she informs him that she doesn't shop there anymore, because the prices are too high and the same merchandise can be had elsewhere. As the stock price begins its descent to $16, the husband wonders why this investing game is so hard.

The final lesson
The point he missed, of course, is this: Pay attention to the world around you, find out why successful businesses are successful, and get into great companies when they're still small.

These simple lessons from Lynch are among the guiding principles Tom and his team have employed in selecting small-cap stocks for Hidden Gems members. Their scorecard shows how successful these principles have been, with 31% total average returns in the three years since the service began, versus 13% for identical amounts invested in the S&P 500.

If you'd like to see all of the recommended stocks (including two new ones to be released at noon ET today) and learn more about investing the Peter Lynch way, Tom is offering a 30-day free trial. Here's more info.

Coca-Cola is an Inside Value pick, while Merck was a former Income Investor selection.

Rex Moore credits Peter Lynch with stoking his investing passion many years ago. He owns no companies mentioned in this story. The Fool's disclosure policy is one up on Wall Street's.