How to Invest the Peter Lynch Way

Invest the Peter Lynch way

Peter Lynch is a household name that comes up frequently in the stock market. He rose to this status after making a 29.2% average annual return in his 13 years of managing the Fidelity Magellan Fund. Because of this feat, Times Magazine once described him as “America’s number one money manager.” In addition, he is the author of One Up on Wall Street and Beating the Street, some best-selling investment books.

Lynch was able to achieve this success by following some basic investment principles. His well-known strategy combines both value and growth investment principles. Below are four of his principles;

Invest the Peter Lynch Way 1: Know What You Own

Invest the peter lynch way
Source: YouTube

If we could summarize all of Lynch’s ideas into a sentence, it would be this: Know what you own. He often stressed the importance of having a good understanding of the company behind the stock you own. Contrary to what some people think, stocks are not lottery tickets. He observed an alarming trend among investors where most could not state their reasons for owning stocks.

He believes you don’t fully understand the stock you own unless you can explain it to a ten-year-old in two minutes or less. Because a particular stock is going up is not enough reason to own it. The why behind a stock is one of the things you should know before buying a stock to hold.

Invest the Peter Lynch Way 2: Use Your Natural Advantage

Invest the peter lynch way
Source: Seeking Alpha

Peter Lynch-inspired Stock Model Nearly Doubles The Market Since 2003

In several instances, Lynch suggested that small investors have a huge advantage over large investors. The presence of big institutions dominating the market is a positive for small investors because they push stocks into unusual lows and highs. As an individual investor, you don’t need to pick too many stocks. You only need a few good ones in a decade.

Still, on advantage, Lynch would often advise investors to buy in the already familiar industry. You can easily spot the emerging opportunities first and take advantage of them. This gives you an edge over other investors.

To make money, you need a competitive advantage over most. Start with stocks in your industry. You can see the opportunity first and make the most of it. He pointed out that people don’t make use of their natural advantage. He would often see people in the restaurant industry buying a biotechnology stock or people in IT buying oil stocks. They usually end up pulling out the flower and watering the weed.

Invest the Peter Lynch Way 3: Do Your Research

Lynch pointed out that most investors do not carry out proper stock research. For example, most do not look into the sales revenue and take time to look through the financial statements before putting money in stocks. If humans could be careful about making inquiries before buying a car or property, you should apply the same due diligence to stocks. He believes that with the correct information and knowledge, people can make an informed decision regarding stocks.

Invest the Peter Lynch Way 4: Understanding the Storyline

Invest the peter lynch way
Source: Trade Brains

Lynch believes that understanding a company helps investors predict future expectations. In his book One Up on Wall Street, Lynch categorized stocks into six groups or storylines;

Slow growers: These are large, aging companies with a large dividend payout. These companies pay a large dividend because their dividend stocks are not precisely fast growers. There is little they can do to capture a significant market share, so they generally return most of their profits to their shareholders. A good example is a dividend stock in a utility company.

Stalwart stocks: These are large firms growing at a pace ahead that returns a 10-12% annual growth. These stocks are most common, and typical examples are KO, PG, and MMM. This value is better than the market average but not explosive. These stocks are generally stable blue-chip stocks.

Fast growers: This category of companies made Lynch a household name. He was good at identifying these small, aggressive new companies he often referred to as ten baggers. Typically, these stocks grow at 20-35% and have the potential to give you a tenfold return. Examples are Amazon, Tesla, etc.

Cyclical: These stocks make more reference to the industry than the stock itself. He believes that industries expand or contract in cycles, and these stocks exaggerate the market movements. However, they come out of recessionary times or poor markets better than the others. Examples are autos, airlines, tires, steel, and chemicals stocks.

Turnarounds: These are battered or depressed companies nearing bankruptcy. They usually experience no growth and are therefore difficult to buy.

Asset plays: Are companies with assets worth more than their current share price. An example was Blackberry in 2012.

Understanding the different categories of stocks helps investors understand how to invest their money better.

Some Mistakes Investors Make

Invest the peter lynch way
Source: Quora

Not Looking at the Balance Sheet

It is imperative to go through the financial statement of the company you’re investing with. For example, a debt-free company can’t go bankrupt. Some things to look out for while going through the financial statement are a high percentage of the sale, more than two prices to earnings growth ratio, rate of debt, etc.

Investing Purely Based on Others' Opinions

Lynch often warned investors to stay clear of hot stocks that are most talked about everywhere. In most cases, they never end well.

Investing Purely Based on Others' Opinions

Lynch often warned investors to stay clear of hot stocks that are most talked about everywhere. In most cases, they never end well.

Trying to Predict the Market

He believes that no one can predict the economy. So, rather than trying to predict, it is more helpful to study history, which points to a market correction. He highlights that market correction happens every six years when it goes down by 25%.

Not thinking long term

Lynch claimed that most of his investments that performed well had a minimum of five years of holding. Studying short-term market changes is a sheer waste of time. Furthermore, investing long-term means, you are ready to accept every negative consequence of stock investing.

Jumping on Every New Fund Offer

Many investors mistake jumping on any new train of new fund offers. Lynch believes it’s better to stick to existing schemes than jump on new offers. Even if the new fund offer is promising, he advises waiting it out before joining.

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