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Of all the great investors throughout history, some feel Peter Lynch offered more simple and practical advice than any other guru.  He started out as an ordinary mutual fund manager for Fidelity Investments, managing their Magellan fund.

He started in 1977 and by the time he left the fund in 1990, he had achieved average annualised returns of 29%.  He “beat the street” in every year but two.

That kind of return over such an extended period is amazing enough, but when you factor in the size of the investment fund he was managing, a 29% return is truly beyond belief.

In 1977, the Fidelity Magellan Fund had 18 million dollars in assets, which he grew to $14 billion by 1990.  It is difficult for most retail investors to imagine, but the larger the dollar amount you have to invest, the harder it becomes to invest.  At one point, the Magellan Fund owned 14,000 different shares.

Lynch wrote several investing books in which he discussed his investing principles and philosophy.  Filled with anecdotes, his works are easy to read and full of easily understandable advice.

You can search the Internet for Peter Lynch’s investing principles and you will find lists of eight and lists of twenty-one.

From those lists, we have distilled a few that may capture the essence of his approach.  With all due apologies to Peter Lynch, here is our list:

•    If you can’t understand it, don’t buy it.

•    Do your own homework.

•    Look under the company’s hood, not the market’s.

•    Forget about the short term ups and downs of the market.

•    List the reasons you are buying the shares.

•    Stay away from “story” shares.

If You Can’t Understand It, Don’t Buy It

You may have heard this principle expressed as buy what you know.  Lynch invested in the pre-Internet age and today we believe it is entirely possible to learn what you do not know.  

If you stumble on shares in an industry about which you know nothing, do not run away.  Instead, see what you can learn.  However, at some point, if you cannot learn enough to understand what it is the company does to make money, move on.

Do Your Own Homework

Lynch was not the first guru to stress the importance of research and he will certainly not be the last.  Yet retail investors everywhere fail to heed this advice, even when the Internet makes research within the reach of anyone.

Check the Internet discussion blogs and you will find people ready to part with their investment dollars based on the advice of someone they have never met and have no reason to trust.

Even if you find a share recommended by a great financial analyst from a respected firm, do your own homework.

Look under the Company’s Hood, not the Market’s.

Lynch was definitely a “bottoms-up” investor.  He pointed out no one can predict market moves, so, in his words, why bother trying.  Today there is an investing strategy known as “top-down” investing that starts with an assessment of macro-economic conditions.

Lynch’s advice was simple.  Buy companies, not markets.  As a self-convincing exercise, run five-year price charts on some of your favorite shares and see how they fared before, during, and after the GFC (Great Financial Crisis).  Most have regained much of the value they lost while others are well on their way.  And remember, that was one of the greatest financial crises in history.

Anyone with cash to invest during that crisis did very well by investing in sound companies.

Forget Market Ups and Downs

This principle flows from the previous one.  Lynch believed in long-term investing.  Note that for him long-term did not mean forever.  One of his sayings was “Buy in Gloom, Sell in Boom.”  He simply believed you should not sell out because the tsunami in Japan and the rising price of oil and the flooding in Queensland have rattled the markets.  In Lynch’s more famous words, “there’s always something to worry about”.

List the Reasons You’re Buying the Shares

Warren Buffett, another legendary investor, loves to talk about his investment thesis for a share purchase decision.  Lynch felt every investor should be able to explain in three sentences or less, their “thesis” in language understandable to an 11-year old child.

Replacing the word “thesis” with the phrase “reasons for buying” appears to us to be language an 11-year old could comprehend.  Simply put, write out the “whys.”

This list of reasons, or investment thesis if you prefer, then serves as your “sell” signal.  Investors like Lynch and Buffett are subject to unfounded criticism when the ignorant talk about the folly of holding a share forever.

Both men believe in rigorous research and ongoing monitoring of the shares they own.  When there is a fundamental change in the original investment thesis, it is time to sell.  In our terms, if one of the reasons you bought the shares is no longer true, sell and move on.

One of the major mistakes made by retail investors is not having sell criteria.  The list of buy reasons is a simple and fundamentally sound approach to setting such criteria.

Stay Away from Story Shares

Many retail investors love story stocks – a great story about an amazing innovation that will one day make a fortune.  The trouble with almost all story stocks is they have yet to show even one dime in profit.  Lynch called them “long shots.”  He claims he invested in 25 long shots over his storied career and none earned him a dime.

If you have not already done so, take the time to read one of Lynch’s books.  As you may know, gurus love to point out that great investors tend to be great readers.

>>Back to the newsletter to view other articles – June 13th 2011

 

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