Financial Luminary: Peter Lynch, Part II

by Dual Income No Kids on October 3, 2009 · 0 comments

My last post I talked about who Peter Lynch is, while today I’m going to talk about his stock picking philosophy, his successes, and how he has influenced me.

Peter Lynch is most famous for his work with Fidelity Investments managing the Magellan Fund (symbol: FMAGX). And for good reason; during Lynch’s 13 year tenure (1977-1990) heading the fund, it averaged an annual return of 29%. 29%! That number continues to just amaze me; if a man like that has something to say about how money should be invested, I will certainly listen.

As a software engineer I am quite drawn to technology. I’ve read more than a couple books on technical analysis and mathematical approaches to picking winning stocks (in fact, I just read an interesting paper on using Monte Carlo methods for picking options) and I find that I’m very attracted to that manner of investing. Although I know that the markets are too complex and too driven by emotion and psychology to be deterministic, there is still something about formulating a mathematical framework for picking stocks that makes me want to keep buying those books and reading those papers.

Peter Lynch’s investment philosophy couldn’t be more of a 180. Lynch was always a very hands-on investor. His first step was to identify companies that fit his aggressive style. He tried to achieve a certain degree of balance with his portfolio (breaking stocks up into 6 distinct categories) but his real bread winners were his “fast growers”. He liked to find small, aggressive companies with high growth (but not too high; he thought that any annual growth over 30% a year was unsustainable and should be avoided). He liked companies that hadn’t received a lot of attention but who are reasonably priced and perhaps most importantly, carry low debt and are consistently profitable.

This, however, is just the first step towards investing. Generating a list of prospectively worthwhile stocks is nice, but what really made Lynch successful was his exhaustive research. He was famous to spending a lot of time on the road, visiting companies all over the country in person so that he could get a feel about how the company was really doing and where they might be headed.

He wanted to know everything he could about a prospective company before buying into them. Sometimes having a lot of data can be a bad thing (read Malcolm Gladwell’s “Blink” for more on this) but in the case of investing, the more good information you have, the better chance you have of creating wealth. And Peter Lynch was famous for being able to not only acquire good information, but also use that great volume of information to form an opinion as to whether that company is a good investment or not.

Lynch is also famous for his championing of “investing in what you know.” He tells stories of investing in companies that make certain products that his wife or kids have used (still exhaustively researching them, of course) and sticking to financial sectors that he has a strong knowledge basis in. This idea of a common person being able to spot trends and know what is a good product out in the marketplace before a fund manager can reach the same conclusion by reading financial data is a powerful idea, and one that has made his investing tips very palatable to the common investor.

I feel as if I personally have benefited greatly from Lynch’s advice. As I mentioned earlier in this post, I tend to gravitate towards the mathematical side of investing, at my own peril at times. But Peter Lynch is a strong example for the opposite approach. He really drives home the point that there isn’t a magic formula; that good stock picking is based on information and making good judgment calls based on that information. His idea of investing in what you know is strong advice that anyone can take and use to build wealth. In fact, we have the best example of this right here with James and Miel and their decision to invest in NOKIA. The quote that I found most interesting from that post was this:

“4) Having lived in Finland, I believe strongly in the Finnish persuasion for frugality and believe that the business is run well.”

What a great idea! Efficiently running your business is such an obvious indicator of success (and plays into Lynch’s emphasis on consistency) and James and Miel made a judgment call based on what they know: their personal experience. So far it seems to have been a pretty good call by our Grand Poobahs. There isn’t a mathematical model on earth that could describe Finnish frugality and how it affected their decision. But it was an important factor when they were considering investing. Peter Lynch would be proud.

Peter Lynch is justly considered one of the best stock pickers of all time; and his investment philosophy, while on the surface it appears simple, could be of use to any investor. It’s hard to argue with someone who averaged 30% annual returns over a 13 year period.

Twitter: @michael_dink

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