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5 investing gems from Peter Lynch
Chandnee Sinha
 
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July 26, 2007 14:26 IST

Every country has its famous mutual fund managers. The United States of America has had its fair share of them, but probably none more famous than Peter Lynch.

Lynch started managing the Fidelity Magellan Fund, in 1977, and was at the helm of things for the next 13 years. In 11 out of the 13 years, the Magellan fund gave more returns than the S&P 500 index, delivering an astonishing return of 29% per year.

One dollar invested in the scheme in 1977 would have amounted to around $27 by the time Lynch retired from active fund management in 1990.

Since 1990, Lynch has gotten around to writing various books on investing along with journalist John Rothschild. The first of the series being One Up on the Wall Street.

In this book he shares his thought process and the steps he followed that made him such a successful fund manager.

Here are five investing gems from this book:

1. Don't listen to stock market experts

The first and foremost advice that Lynch gives is to stop listening to experts. He writes, "But the rule number one, in my book, is: Stop listening to professionals! Twenty years in this business 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."

Having said that Lynch feels that investing on their own for investors is a difficult exercise. He further writes, "That means ignoring the hot tips, the recommendations from brokerage houses, and the latest 'can't miss' suggestions from your favourite newsletter -- in favour of your own research. It means ignoring the stocks that you hear Peter Lynch, or some similar authority, is buying."

2. Invest in mutual funds

If an investor feels that he has the expertise to invest on his own, then he should be trying to outperform the market, i.e. generate a return that is greater than that of the market. If he cannot, the simple thing to do is to just invest in mutual funds.

Lynch writes, "Moreover, when you pick up your own stocks, you ought to outperform the experts. Otherwise, why bother?"

If the investor does not have the capability to outperform the market, then it doesn't make much sense for him to go about investing in stocks. Investing in mutual funds is a much better bet. "The mutual fund is a wonderful invention for people who have neither the time nor the inclination to test their wits against the stock market, as well as for people with small amount of money to invest who seek diversification," he writes further.

3. Believe in the power of compounding

Lynch narrates a small story to illustrate the power of compounding and drive home the fact that the earlier you start investing the better it is.

"Consider the Indians of Manhattan, who in 1625 sold all their real estate to a group of immigrants for $24 in trinkets and beads. For 362 years, the Indians have been the subjects of cruel jokes because of it -- but it turns out that they may have made a better deal than the buyers who got the island. At 8% interest on $24 (Note: Let's suspend our disbelief and assume they converted the trinkets to cash) compounded over all those years, the Indians would have built up a net worth just short $30 trillion, while the latest tax records from the Borough of Manhattan show the real estate to be worth only $28.1 billion. Give Manhattan the benefit of doubt: that $28.1 billion is the assessed value, and for all anybody knows, it may be worth twice that on the open market. So Manhattan's worth $56.2 billion. Either way, the Indians could be ahead by $29 trillion and change."

4. You don't need an education in business subjects to pick up stocks

Peter Lynch did not study accounting, neither did he get around to doing an MBA, the subjects considered most necessary to pick up the right stocks.

As he writes, "In college, except for obligatory courses, I avoided science, math, and accounting -- all normal preparation for business."

"Investing in stocks is an art, not a science, and people who've been trained to rigidly quantify everything have a big disadvantage. If stockpicking could be quantified, you could rent time on the nearest Cray computer and make a fortune. But it doesn't work that way. All the math you need in the stock market (Chrysler's got $1 billion in cash, $500 million in long term debt, etc) you get in the fourth grade."

So what is it that made him so successful in picking up the right kind of stocks.

"Logic is the subject that's helped me the most in picking stocks, if only because it taught me to identify the peculiar illogic of Wall Street. Actually Wall Street thinks just as the Greeks did. The early Greeks used to sit around for days and debate how many teeth a horse has. They thought they could figure it out by just sitting there, instead of checking the horse. A lot of investors sit around and debate, whether a stock is going up, as if the financial muse will give them the answer, instead of checking the company."

5. Learn to trust your gut feeling

Since investing is more an art than a science. Things are never very clear in the stock market. "Things are never clear on Wall Street, or when they are, then it's too late to profit from them. The scientific mind that needs to know all the data will be thwarted here," pens Lynch.

Hence, the most important thing in such a situation is to trust your gut feel. As Lynch says, "It is the rare investor who doesn't secretly harbour the conviction that he or she has a knack for divining stock prices or gold prices or interest rates. Inspite of the fact that most of us have been proven wrong again and again, it's uncanny how often people feel most strongly that stocks are going to go up or the economy is going to improve just when the opposite occurs."

"When it comes to predicting the market, the important skill here is not listening, it's snoring. The trick is not to learn to trust your gut feelings, but rather to discipline yourself to ignore them. Stand by your stocks as long as the fundamental story of the company hasn't changed."

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