Peter Lynch’s 25 Golden Rules for Investing

Peter Lynch is an American investor, mutual fund manager, and philanthropist. As the manager of the Magellan Fund at Fidelity Investments between 1977 and 1990, Lynch averaged a 29.2% annual return, consistently more than double the S&P 500 stock market index and making it the best-performing mutual fund in the world.

During his 13-year tenure, assets under management increased from US$18 million to $14 billion.

His most famous investment principle is, “invest in what you know,” popularizing the economic concept of “local knowledge”. Since most people tend to become experts in certain fields, applying this basic “invest in what you know” principle helps individual investors find good undervalued stocks. Lynch uses this principle as a starting point for investors. He has also often said that the individual investor is potentially more capable of making money from stocks than a fund manager because they are able to spot good investments in their day-to-day lives before Wall Street.

Lynch popularized the stock investment strategy “GARP” (Growth At A Reasonable Price), which is a hybrid stock-picking approach that balances Growth investing potential for share-price increases with the discipline of Value investing to avoid buying overpriced stocks.

He also coined the phrase “ten bagger” in a financial context. This refers to an investment that is worth ten times its original purchase price and comes from baseball where the number of “bags” or “bases” that a batter can run to is a measure of the success of that runner’s hit. A baseball player who hits a home run will pass all four bases, and so such a hit is sometimes called a four-bagger.

Before investing in a company, Lynch analyzes the following factors:

• Year-by-year earnings: Look for stability and consistency, and an upward trend.
• P/E relative to historical average: The price-earnings ratio should be in the lower range of its historical average.
• P/E relative to industry average: The price-earnings ratio should be below the industry average.
• P/E relative to earnings growth rate: A price-earnings ratio of half the level of historical earnings growth is attractive; relative ratios above 2.0 are unattractive. For dividend-paying stocks, use the price-earnings ratio divided by the sum of the earnings growth rate and dividend yield-ratios below 0.5 are attractive, ratios above 1.0 are poor.
• Debt-equity ratio: The company’s balance sheet should be strong, with low levels of debt relative to equity financing, and be particularly wary of high levels of bank debt.
• Net cash per share: The net cash per share relative to share price should be high.
• Dividends and payout ratio: For investors seeking dividend-paying firms, look for a low payout ratio (earnings per share divided by dividends per share) and long records (20 to 30 years) of regularly raising dividends.
• Inventories: Particularly important for cyclicals, inventories that are piling up are a warning flag, particularly if growing faster than sales.

And here are his 25 Golden Rules for Investing:

1. Investing is fun and exciting, but dangerous if you don’t do any work.

2. Your investor’s edge is not something you get from Wall Street experts. It’s something you already have. You can outperform the experts if you use your edge by investing in companies or industries you already understand.

3. Over the past 3 decades, the stock market has come to be dominated by a herd of professional investors. Contrary to popular belief, this makes it easier for the amateur investor. You can beat the market by ignoring the herd.

4. Behind every stock is a company. Find out what it’s doing.

5. Often, there is no correlation between the success of a company’s operations and the success of its stock over a few months or even a few years. In the long term, there is a 100% correlation between the success of the company and the success of its stock. This disparity is the key to making money; it pays to be patient and to own successful companies.

6. You have to know what you own, and why you own it. “This baby is a cinch to go up” doesn’t count.

7. Long shots almost always miss the mark.

8. Owning stocks is like having children — don’t get involved with more than you can handle. The part-time stockpicker probably has time to follow 8–12 companies and to buy and sell shares as conditions warrant. There don’t have to be more than 5 companies in the portfolio at any one time.

9. If you can’t find any companies that you think are attractive, put your money in the bank until you discover some.

10. Never invest in a company without understanding its finances. The biggest losses in stocks come from companies with poor balance sheets. Always look at the balance sheet to see if a company is solvent before you risk your money on it.

11. Avoid hot stocks in hot industries. Great companies in cold, nongrowth industries are consistently big winners.

12. With small companies, you are better off waiting until they turn a profit before you invest.

13. If you are thinking of investing in a troubled industry, buy the companies with staying power. Also, wait for the industry to show signs of revival. Buggy whips and radio tubes were troubled industries that never came back.

14. If you invest $1000 in a stock, all you can lose is $1000, but you stand to gain $10,000 or even $50,000 over time if you are patient. The average person can concentrate on a few good companies, while the fund manager is forced to diversify. By owning too many stocks, you lose this advantage of concentration. It only takes a handful of big winners to make a lifetime of investing worthwhile.

15. In every industry and every region of the country, the observant amateur can find great growth companies long before the professionals have discovered them.

16. A stock market decline is as routine as a January blizzard in Colorado. If you are prepared, it can’t hurt you. A decline is a great opportunity to pick up the bargains left behind by investors who are fleeing the storm in panic.

17. Everyone has the brainpower to make money in stocks. Not everyone has the stomach. If you are susceptible to selling everything in a panic, you ought to avoid stocks and stock mutual funds altogether.

18. There is always something to worry about. Avoid weekend thinking and ignore the latest dire predictions of the newscasters. Sell a stock because the company’s fundamentals deteriorate, not because the sky is falling.

19. Nobody can predict interest rates, the future direction of the economy, or the stock market, Dismiss all such forecasts and concentrate on what’s actually happening to the companies in which you have invested.

20. If you study 10 companies, you will find 1 for which the story is better than expected. If you study 50, you’ll find 5. There are always pleasant surprises to be found in the stock market — companies whose achievements are being overlooked on Wall Street

21. If you don’t study any companies, you have the same success buying stocks as you do in a poker game if you bet without looking at your cards.

22. Time is on your side when you own shares of superior companies. You can afford to be patient — even if you missed Wal-Mart in the first five years, it was a great stock to own in the next five years. Time is against you when you own options.

23. If you have the stomach for stocks, but neither the time nor the inclination to do the homework, invest in equity mutual funds. Here, it’s a good idea to diversify. You should own a few different kinds of funds, with managers who pursue different styles of investing: growth, value small companies, large companies, etc. Investing the six of the same kind of fund is not diversification.

24. Among the major stock markets of the world, the U.S. market ranks 8th in total return over the past decade. You can take advantage of the faster-growing economies by investing some portion of your assets in an overseas fund with a good record.

25. In the long run, a portfolio of well-chosen stocks and/or equity mutual funds will always outperform a portfolio of bonds or a money-market account. In the long run, a portfolio of poorly chosen stocks won’t outperform the money left under the mattress.

Lynch offers a practical approach that can be adapted by many different types of investors, from those emphasizing fast growth to those who prefer more stable, dividend-producing investments. His strategy involves considerable hands-on research, but his books provide lots of practical advice on what to look for in an individual firm, and how to view the market as a whole.

Lynch sums up stock investing and his outlook best:

“Frequent follies notwithstanding, I continue to be optimistic about America, Americans, and investing in general. When you invest in stocks, you have to have a basic faith in human nature, in capitalism, in the country at large, and in future prosperity in general. So far, nothing’s been strong enough to shake me out of it.”

Famous quotes from Peter Lynch:

1. “The key to making money in stocks is not to get scared out of them.”
2. “Investing in stocks is an art, not a science, and people who’ve been trained to rigidly quantify everything have a big disadvantage.”
3. “All the math you need in the stock market you get in the fourth grade.”
4. “Time is on your side when you own shares of superior companies.”
5. “In this business, if you’re good, you’re right six times out of ten. You’re never going to be right nine times out of ten.”
6. “That’s not to say there’s no such thing as an overvalued market, but there’s no point worrying about it.”
7. “The natural-born investor is a myth.”
8. “The simpler it is, the better I like it.”
9. “As I look back on it now, it’s obvious that studying history and philosophy was much better preparation for the stock market than, say, studying statistics.”
10. “Know what you own, and know why you own it.”
11. “If you can’t find any companies that you think are attractive, put your money in the bank until you discover some.”
12. “ If you can follow only one bit of data, follow the earnings.”
13. “There’s no shame in losing money on a stock. Everybody does it. What is shameful is to hold on to a stock, or worse, to buy more of it when the fundamentals are deteriorating.”
14. “Owning stocks is like having children — don’t get involved with more than you can handle.”
15. “You have to keep your priorities straight if you plan to do well in stocks.”
16. “The basic story remains simple and never-ending. Stocks aren’t lottery tickets. There’s a company attached to every share.”
17. “Behind every stock is a company. Find out what it’s doing.”
18. “Whenever you invest in any company, you’re looking for its market cap to rise. This can’t happen unless buyers are paying higher prices for the shares, making your investment more valuable.”
19. “When you sell in desperation, you always sell cheap.”
20. “You have to say to yourself, “If I’m right, how much am I going to make? If I’m wrong, how much am I going to lose?” That’s the risk/reward ratio.”

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