If you are looking for investing strategies implemented by one of the greatest money managers of all time, look no further than Beating the Street.
The author, Peter Lynch, spent 13 years managing the Fidelity Magellan Fund which was ranked the top general equity mutual fund in the nation. In this book, he outlines his successful process for identifying investments that beat the market.
Buy What You Know
For the most part, the main point in Beating the Street is fairly straightforward. The key theme in this book centers around buying what you know.
Often, this strategy implies buying stock in businesses that you use on a daily basis and you find familiar. Ultimately, you understand these companies’ products and services because YOU are a customer.
We all consume products and services from some of the largest companies in the world. Perhaps, you own an iPhone or other Apple product. We all have a special affinity for those Disney classics. If you enjoy exercising, you may want to invest in the company that makes your yoga-wear or training shorts.
Overall, Lynch advocates for individual investors to keep their investing simple.
Why buy stock in companies that you can’t even explain what they do?
“Buy what you know” is a theme not only in Beating the Street, but many other successful investors have the same viewpoint. For instance, Warren Buffett has avoided most of those high-flying tech companies his whole career. As he’s explained, Buffett simply 1) doesn’t understand the business and 2) can’t predict the business and future market dynamics.
Therefore, even Warren Buffett “buys what he knows.”
St. Agnes Portfolio
Lynch starts Beating the Street with a compelling example to illustrate the power of “buying what you know.”
The stocks in the “St. Agnes Portfolio” were chosen by Ms. Joan Morrissey’s 7th grade class at St. Agnes School in Massachusetts. These 7th graders randomly picked a portfolio of stocks comprised of the companies they personally used and loved. Examples included Wal-Mart, Nike, and PepsiCo.
Over a two-year period, the students’ portfolio returned nearly 70% compared to market returns of 26%.
Lynch uses this example to explain that even children can pick stocks that outperform the stock market by simply investing in what they know.
While many on Wall Street spend nearly a decade in school learning complex financial concepts with many earning a six-figure M.B.A., this 7th grade class outperformed 99% of equity mutual funds.
Lynch makes the argument that investors would be better served by simplifying their investment strategy.
Never invest in any idea you can’t illustrate with a crayon
By following this rule, Lynch contends that many amateur and professional money managers alike would avoid ignoring profitably companies and investing in ventures that lose money.
Lynch also outlines how he picked stocks for his successful fund by buying the stock of popular products. By going to the mall and scouting popular stores or identifying the public’s favorite dining spots, Lynch explains that you can profit from consumer spending behaviors.
Do Not Fear Stock Investing – Fear Inflation
Another key theme Lynch focuses relates to investor fear. Often, fear grips those who want to invest but are afraid of losing their hard-earned money.
Lynch contends that the key to making money in stocks is to not get scared out of them.
In today’s news environment that focuses on scaring viewers with the “shock factor,” Lynch says too much media has the potential to keep the average retail investor sidelined.
Perhaps, your political party is poised to lose the majority. Both trade wars and real wars could impact your portfolio. Maybe, there’s been a viral outbreak with the potential for widespread impact.
All of the sensationalized news articles and programs have the potential to scare you into reacting in a way that’s detrimental to your long-term future.
Instead, investors shouldn’t worry about their stocks but rather continue to hold their investments for the long run.
You can’t see the future through a rear view mirror
Instead of focusing on negative events, focus on what lies ahead. Often, the public mood isn’t indicative of the future performance of the stock market.
Perhaps, if public sentiment is too negative, there’s more upside in the market as people begin realizing things aren’t that bad.
Instead of investing in equities, these individuals often opt for more conservative investments such as bonds or certificate of deposits (CDs). While these instruments offer security, they do not protect investors from the erosion of their dollars by inflation.
By contrast, stocks pay dividends and appreciate in value which allows your returns to compound over decades. This helps you build wealth and stamp out the impacts of inflation.
Bonds vs. Stocks
Lynch devotes an entire chapter (Chapter 3) to discussing the two main tools in an individual’s portfolio construction:
- Stocks
- Bonds
While bonds play an important part to providing stability and income to a retiree’s portfolio, Lynch hopes to convince readers that “stocks are more generous” than bonds.
Historically, stocks have returned 10.3% annually over the last 70 years. By comparison, long-term government bonds have only produced 4.8% annual returns.
Stocks generally outperform bonds thanks to overall economic expansion. As companies grow their revenues and consequently earn more money, they increase their earnings-per-share and dividends.
However, the bond market is much larger than the stock market. In fact, the bond market is $10 TRILLION larger than the $30 Trillion stock market.
Conventional investing wisdom recommends stocks for younger investors as they build their wealth. Once they achieve a certain level of assets capable of sustaining their lifestyle in retirement, most wealth advisors take a “risk off approach” by advocating for a heavier bond portfolio. Elderly individuals are drawn to the bond market because of the consistent, relatively stable interest yields they produce.
However, Lynch explains that this advice is becoming obsolete.
People are living much longer than they used to live. A healthy 62-year-old is looking at a 20-year time horizon where they’ll need their portfolio to both support their lifestyle and beat inflation.
Therefore, Lynch recommends increasing the stock mix in most investors’ portfolios.
Lynch’s advice to Portfolio Construction
Beating the Street provides analysis and examples of a wide-range of financial products ranging from no-load vs. load mutual funds to sector-based funds.
In summary, Lynch suggests the following strategies when constructing your own portfolio:
- Put as much as possible into stock funds. Dividends can more than offset any interest you’d receive in bonds
- If you do own government bonds, buy them outright from the U.S. Treasury and avoid bonds funds
- Know the stocks you own and compare them the relevant class of funds (i.e. growth, value, etc.)
- Divide your money into 3-4 types of stock funds (growth, value, emerging markets, etc.)
- When adding new money, invest in the underperforming fund
- Concentrate on funds with solid track records of success.
Identify Undervalued Stocks in Depressed Industries
While many investors stray away from negative news, Lynch sees depressed industries as an opportunity to buy undervalued stock.
Often, headline news and market sentiment move investors to fear and panic in specific industries. This can be a welcome opportunity for the contrarian investor to swoop in and buy stock at a discount.
However, you should not purchase just any company in an out of favor industry. Lynch recommends buying the best companies in a downtrodden industry to protect your hard-earned dollars. These well-run, highly capitalized companies may be set to take advantage of cyclical downturns by consolidation or establishing a greater market share in their respective industry. When the cycle turns and business improves, the best companies can return stronger than ever.
Reassess and Reevaluate
Finally, Lynch outlines that you should continually monitor your stocks and consistently reevaluate your investment thesis.
While many investors reevaluate their portfolio, they often do so out of fear and look for opportunities to sell. While selling represents one choice investors can make, Lynch explains that your evaluation may lead you to invest more. Often, winning companies and stocks continue on their trajectory and represent a solid investment thesis.
Even if you do not sell or do not buy more of a particular stock, you should stay abreast of your companies’ future plans and prospects. Staying on top of the latest news and reports helps you monitor your investments and stay informed. Through your research, you may identify new opportunities in which to invest.
Beating the Street: Yes, Even You Can Too!
Beating the Street by Peter Lynch should be a read on every investor’s itinerary. The education and insights Lynch outlines offer investment thesis based on human behavior that are especially relevant in today’s consumer-driven economy.
If you are looking for a read to enhance your knowledge on investing, look no further than this helpful book written by one of the most successful money managers on Wall Street.
Get your copy here and start learning to beat the street today!