Secrets of Peter Lynch To Make Money With Stocks.
Learn to make money with the stock market.
It is May 1977. A young portfolio manager takes over the Fidelity Magellan mutual fund. At the time, the fund had $20 million in assets under management. In a little over a decade, this 33-year-old investor transformed the fund into one of the largest in the world.
In 1990, the Fidelity Magellan Mutual Fund had over $14 billion in assets under management.
Over that period, the fund averaged a 29.2% annual return. To help you understand what this means, imagine that you invested $10,000 in this fund in 1977. Thirteen years later, you would have been sitting on $280,000.
The young portfolio manager who made the Fidelity Magellan Mutual Fund so phenomenally successful in the 1980s is Peter Lynch. You’ve obviously heard his name before if you’re interested in the investment world.
For some, there is even a debate between Peter Lynch and Warren Buffett to know who is the greatest investor of all time. It is to say that Peter Lynch is a respected person.
In what follows, I propose to unveil to you the great principles of investment that allowed Peter Lynch to know such a success. You will see that by applying his secrets, you will maximize your chances to succeed in making money with the stock market.
Only buy what you understand
In his best-selling book “One Up On Wall Street: How To Use What You Already Know To Make Money In The Market”, Peter Lynch explains that you should only buy stocks of companies whose business you understand. His mantra is reflected in this famous quote:
“Buy what you know.”
There’s no need to try to make it complicated or to go after stocks of companies you know virtually nothing about.
Peter Lynch believes that the best chance for non-professional investors to make money in the stock market is to stick with companies they understand. This is also one of Warren Buffett’s main principles.
If you don’t understand anything about the biotech sector, you should probably stay away from it. This will prevent you from making mistakes due to your ignorance.
Instead, focus on companies you understand. You will minimize your chances of making mistakes since your knowledge will be maximized.
Do extensive research
Great investors have long understood what makes people lose money in life. That thing is ignorance. So you should seek to reduce your ignorance before you invest in a company.
The more your ignorance is reduced, the more you will be able to make good decisions.
There is a reason why Warren Buffett reads up to 500 pages a day. He seeks to reduce his ignorance in all areas. The lasting success he has achieved for more than 60 years comes from this will to improve every day.
To return to Peter Lynch, he believes that the more methodically you evaluate stocks, the more likely you are to invest in the best ones. Peter Lynch recommends that investors become familiar with basic metrics in the investment world.
You don’t have to be a mathematical genius to understand the metrics he details in his best-selling book “One Up On Wall Street: How To Use What You Already Know To Make Money In The Market”:
Percent of sales. If a product or service attracts you to a company, you should check the percentage of sales it represents for the company. If it represents only 5%, this product or service will have only a marginal impact on the company’s results.
Price-to-earnings ratio. This is a metric that is widely used in the investment world. It is very useful for comparing companies operating in the same industry. The P/E ratio is calculated by dividing a stock’s annual earnings by its current price. It represents the money that investors are willing to pay for each dollar earned by the company.
Price-to-earnings growth (PEG) ratio. This metric is the stock’s P/E ratio divided by its earnings growth rate. It is more useful than the P/E ratio, especially when you are going to compare fast-growing companies with slower-growing ones.
Cash position. Peter Lynch ideally targets companies that have a positive net cash position. This means that they have more cash on their balance sheet than debt. This metric should be taken into consideration.
Debt-to-equity ratio. This metric tells you how much a company owes relative to how much it owes. It gives you an indication of the financial strength of a company.
Book value. The value of a company minus its liabilities expressed on a per-share basis. Peter Lynch preferred to buy stocks for less than their book value, but only if the business otherwise looked strong.
Cash flow. The amount of money a company takes in, minus the amount it pays out. This will tell you if a company is making money.
Analyzing these metrics in detail will lead you to select better stocks.
Forget about timing the market, invest for the long run
Many people see the stock market as something risky and difficult to predict. This proves to be true in the short term. Those who try to time the market take risks and often lose a lot of money.
But if you can invest for the long term, then you will find that things are not as unpredictable as they seem in the short term, as Peter Lynch says:
“Absent a lot of surprises, stocks are relatively predictable over 10–20 years. As to whether they’re going to be higher or lower in two to three years, you may as well flip a coin to decide.”
The figures confirm what Peter Lynch says.
The average investor in an equity fund has a generated annualized return of less than 4%. This is all the more damaging because if that investor had invested in an S&P 500 index fund, he or she could have achieved a return of just over 10%.
The problem with average investors is that they keep changing their positions, which is counterproductive. Having a long-term vision and sticking to it is the key for Peter Lynch.
Diversify your portfolio
Diversification of one’s stock portfolio is a divisive topic in the investment world. Warren Buffett and Peter Lynch have totally different views on this point.
Warren Buffett thinks that excessive diversification has only little interest:
“Diversification is a protection against ignorance. It makes very little sense for those who know what they’re doing.”
Peter Lynch believes the exact opposite. During the 1980s, the Magellan Fund had over 1,000 individual stock positions sometimes. This is five times more than the number of positions held by the average equity mutual fund.
For Peter Lynch, it is essential to invest in companies operating in different industries, with different sizes, and different growth potential as well.
Be careful not to misunderstand this principle used by Peter Lynch. Diversification is not an obligation. It must be used to be able to benefit from the best opportunities at any time. If Peter Lynch did not have any position in the energy sector, he would not obligatorily buy shares of a company in this sector.
Peter Lynch would have done so only if he had found in this sector a well-managed company with a reasonable valuation, and excellent growth potential.
Focus on business that Wall Street overlooks
Peter Lynch always said that the average investor could be as successful as the professionals by following the right investment principles. Better yet, he often said that the average investor could do better thanks to some specific advantages.
It’s all about the scale effect here. It’s easier to double $10,000 than to double $10 billion.
The average investor can take advantage of opportunities on small companies that Wall Street will tend to overlook. For Peter Lynch, it was common for stocks of smaller, lesser-known companies to be mispriced.
By doing the right research, you can find such opportunities yourself that will make you a lot of money by taking advantage of the big moves in these companies as Peter Lynch points out:
“Big companies have small moves. Small companies have big moves.”
Don’t be afraid to avoid the hottest stock in the hottest industry
When investing, your emotions are your number one enemy. No matter what happens, you must always make your decisions based on logical reasoning. This will not be an easy task, like FOMO (Fear Of Missing Out) and FUD (Fear, Uncertainty, and Fud) effects can put your nerves to the test.
For Peter Lynch, if there is one action to be avoided at all costs, it is that of a company that everyone keeps talking about:
“If I could avoid a single stock, it would be the hottest stock in the hottest industry.”
From experience, you’ll find that these companies see their stock price skyrocket and then collapse when investors get their feet back on the ground. At that point, they realize that the revenues, profits, or growth potential did not justify the hype.
Be careful not to fall into these traps that can cost you a lot of money.
Final Thoughts
Peter Lynch remains one of the greatest investors of all time. His wise investment principles have made him phenomenally successful. Once again, you’ll notice that patience and long-term vision are key.
This is something that all successful investors have. Time is your greatest natural advantage in life, and this of course applies to the stock market.
It is up to you now to apply Peter Lynch’s investment secrets to achieve success in the stock market.
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