Table of Contents
Introduction
Peter Lynch investment strategy is one of the simplest strategies of all times, but who is he?
Peter Lynch is one of the most revered names in investing. Lynch was the manager of the Fidelity Magellan Fund, performing an average annual return of 29.2% from 1977 to 1990. His returns outperformed almost every other investor, solidifying his place as a household name in finance. However, the thing that makes Lynch’s story even more extraordinary is just how simple his investment methodology was. He didn’t use fancy algorithms or insider secrets, just buying businesses that he understood.
In this blog post, we will take a closer look at Peter Lynch investment strategy — an investor like you and me who had one of the most uncomplicated strategies of all time…
Let’s see how Lynch can teach us to beat 99% of investors hands-down and some insights you could apply in your investment portfolio.
Who is Peter Lynch?
However, before exploring the details of Peter Lynch investment strategy I think it is necessary to know first; who Peter Lynch is and why his strategy has had such a profound impact.
Research Analyst at Fidelity Investments — Prior to starting his career in 1966, Peter Lynch began as a research analyst. He worked his way up over the years and managed to acquire a job as the manager of Fidelity Magellan Fund in 1977. The fund accumulated over $14 billion under his leadership from just $18 million in assets when he retired in 1990.
What made Lynch great was two fold; firstly he had a superb understanding of business and the second was that he could pick companies with above average growth. He is perhaps most famous for popularizing the 3-word investment strategy “Invest in what you know”, urging regular investors to seek out opportunities that they could relate to via their personal experiences. Lynch thought that average people could beat professional investors by putting their hard-earned money into the companies they knew well and had time to investigate properly.
Peter Lynch Investment Strategy Core Principles
Although Peter Lynch investment strategy leans more towards the active side of things, his philosophy can be boiled down into a few simple principles which are just as applicable today as they were when he was running behind-the-scenes at Fidelity. Next, I detail these principles and apply them to your own investments.
- Invest in What You Know
This approach is most famously encapsulated in Lynch’s advice: “Invest in what you know.” He argued that ordinary investors had an inherent edge over professionals because they could see trends and ideas developing in the day-to-day lives before Wall Street did. If you see an up and coming product or store that is always packed, it could be good to look into if the company behind them would also make a sound investment.
How to Apply This Principle:
- Opt for the companies with which you have substantial interactions and knowledge.
- Placements — think about the products/services that you use and can possibly grow.
- In performing its research ofthe financials and business models, one can determine why an investor should consider these companies for investment.
- Do Your Research
Although investing in what you know is a good place to start, he also stressed the importance of doing your own homework. He was of the opinion that it is important to get a good understanding about where a company stands, what they make or deal with and how well positioned are those who run these companies inorder for us to take reasonable calls on investment.
How to Apply This Principle:
- Read about its income statement, balance sheet and cash flow stream.
- Check the management team and its previous ventures.
- Check the competitive position of the company in its industry and growth prospects going forth
- Seek Growth At A Reasonable Price (GARP)
Lynch coined the phrase “Growth at a Reasonable Price” (GARP), which selects stocks that offer fast growth potential, but for Step Lynch GIVESs their shares are still not highly valued. He thought he had uncovered that the secret to great returns was not only buying high-growth companies, but purchasing them at a reasonable price.
How to Apply This Principle:
- Spot companies with viable earnings growth and a good potential going forward
- Check if a company is over valued by using the Price-to-Earnings (P/E) ratio.
- Overpaying for stocks, no matter ho aggressive the growth prospects are.
- Know When to Sell
One of the hardest parts about investing is deciding when to sell. Lynch recommended not to sell simply because a stock price has increased. However, he advised that the key was to hold on when stocks are still in very good companies with strong growth ahead.
How to Apply This Principle:
- Periodically review your investments to make sure the company behind them still has solid fundamentals.
- Sell if the growth prospects of a company have changed, or it becomes severely overvalued.
- Do not get too greedy, though and sell out simply because you see a profit.
- Diversify, But Not Too Much
However, as necessary as diversification is to lower risk, Lynch warned that over-diversifying was likely to dilute returns. He basically said not to run your account into the ground by trying to be in too many stocks but rather concentrate on a few that you know well.
How to Apply This Principle:
- Construct a portfolio of 10-20 stocks in which you have intimate knowledge and that ticks off nearly all the boxes.
- This does not mean all of your positions need to be in different sectors, diversify by industries while still limiting the number securities you own.
- Always choose quality investments over quantity.
- Patience and being in it for the long-term
A strong proponent of long-term investing, Lynch He was convinced that it is impossible to forecast the day-to-day movements of equity prices and felt that in order for an investor to realize high long-term returns, instead he or she needed only form a sensible growth portfolio within their meansand then leave holdings untouched.
How to Apply This Principle:
- Think long-term rather than dwelling on short term market fluctuations.
- Do not just go come up with any impulsive decision based on the volatility of market.
- Develop a sound investment strategy and adhere to your principles throughout any possible bear market.
As a reminder about how Peter Lynch investment strategy was implemented
So, in that regard I also think it would be instructive to provide some real-world examples of companies at different valuation tiers (minimum and maximum) — comparatively sized versions — which fit Peter Lynch’s investment strategy criteria or similar style.
- Apple Inc. (AAPL)
Early 2000’s Apple was not the hipster darling we know today with cutting-edge products like the iPod (and eventually iPhone), that everyone seemed to at least be familiar with. If they had, a savvy investor who recognized the market potential of those products and did their homework should have identified Apple as an outperforming growth stock selling at something less than premium prices. Buying Apple in this era would have been a very sound investment decision; the company grew to be one of the largest and most successful companies ever.
- Starbucks Corporation (SBUX)
On the surface, a company like Starbucks would be another candidate for Lynch’s “invest in what you know” strategy. Starbucks went through a period of rapid expansion in the 1990s and early 2000s, making it ubiquitous on streets around America. And coque apple iphone 7 plus bleu any investors that recognized the potential growth of this bright young $43.3 billion (current sales) business were handsomely rewarded with stock price appreciation as Starbucks became a global coffee colossus!
- Netflix Inc. (NFLX)
A case in point of a company that fit this bill back in its early years was Netflix. After the company moved from being a DVD rental business to an outright streaming behemoth, prices went wild. Smart investors who understood that the future of entertainment was in streaming and invested heavily into Netflix early on were richly rewarded.
Common Errors Using Peter Lynch Investment Strategy
Although the Peter Lynch investment strategy is quite simple, there are a few pitfalls clever investors must avoid in order to maximize their profits.
- Overconfidence
The danger with Lynch’s “just invest in what you know” mind-set is overconfidence. The Sunk Cost Fallacy: Just because something is a company that you know or have purchased its product before does not mean it will be a good investment. Some research and analysis behind your gut is still necessary.
- Ignoring Valuation
It becomes easy to get attracted towards growth stocks, however it is important also not over pay for the same. Buying even the best companies when they are priced too high is a recipe for financial heartache. You should always include valuation metrics in your investment strategy and do not buy because of the hype surrounding a certain product, IP or company.
- Lack of Patience
Lynch made a great point that investors often forget out of our lack, PATIENCE! Short term market movements or stocks selling soon after delivery tend to get the better of us. Being patient and having long-term vision always helps in growing your business.
Bottom Line: Peter Lynch’s Investment Strategy For Your Portfolio
The investment tactics of Peter Lynch are timeless and have created several millionaires. This is how you can have the best chance of beating the market and reaching your financial goals, by sticking to what you know, doing more in-depth analysis than everyone else and being patient.
You see, a critical success factor is to know that Investing in the latest hot thing or market timing does not lead you higher. This is about knowing your investments, paying a fair price for them and keeping it over time. Applying his principles to investment portfolios helps you keep your wealth for a better financial future.
