Each Friday, Money360 reviews a personal finance book.
Peter Lynch is a Wall Street legend. He drove Fidelity’s Magellan mutual fund to some incredible returns in the 1970s and 1980s, year after year. From 1977, when he took over the fund, to 1990, when he retired, that fund grew from $18 million in assets to $14 billion. In those thirteen years, a single share of the Magellan fund increased 900% in value – a 29.2% annual return – and outperformed the stock market by 13.4% annually. That’s an incredible run, without much question the best run of more than ten years ever by a mutual fund manager.
As a result, I decided to dip my toes into his trifecta of books, starting with , which is theoretically Lynch’s “beginner” book – and I liked it quite a bit. It was a great introduction to business and investing for people who don’t know the first thing about business or investing, and coupled with Lynch and Rothchild’s great writing ability, it was a very enjoyable and educational book. So, I know Lynch is a good writer and a great investor. This leaves me practically salivating to read Lynch’s , the subject of this review.
focuses on the idea that observations in your day to day life can help you identify individual stocks that you can make a killing on. What industries do you know well? What companies seem to be surging in that area, based on your observations? Right there, you have the beginnings of some great investing choices. Let’s dig in and see how Lynch describes this all playing out.
The book opens with an impassioned argument from Lynch on behalf of seeking out “tenbaggers,” which refers to stocks that increase in value ten times from their initial investment – buy a stock at 10, when it goes to 100 you have a tenbagger. Lynch makes the astute point that if you buy six stocks, five of them go to zero, and one is a tenbagger, your rate of return is still 66% – an utter killing. Clearly, Lynch’s argument for individual stock investing is that you can occasionally hit a grand slam and make up big time for a few strikeouts.
Preparing to Invest
Most of this section focuses on one key point: ignore the analysts and “experts.” Instead of tuning into CNBC for the “hot” picks, do your own research and find the stocks that you understand and believe in. Also, don’t try to time the market or predict the economy. Very few people can do that well – if Ben Bernanke can’t do it all the time, how can you? The economy is incredibly complex – don’t get egotistical and believe that you know how it works.
Instead, focus on what you know. Look at companies and industries that you’re familiar with. Listen to what people you know are talking about and follow that to your investments. I know personally that I strongly encouraged one investor to buy Google at the IPO because I knew the search engine business pretty well. A friend of mine swore up and down that Starbucks was going to be huge circa 1992. Just listen to what people say, do your own investigating, and follow up on what you find.
Most important of all, Lynch offers three questions that you need to seriously answer before you start investing in individual stocks.
1. Do I own a house? If you don’t, buy a house first. It provides you a stable and permanent place to hang your hat. Some might argue with this advice, but the permanence and investment qualities of a home, the advice does make a lot of sense. That doesn’t mean fully owning a house, but just to be in one and have a stable non-adjustable mortgage that is building equity.
2. Do I need the money? Don’t invest with money that will leave you feeling sick if you lose it. Use extra money, money that won’t devastate you with each loss. You need to be able to stomach big losses with the money without breaking a sweat if you’re going to swing for the fences.
3. Do I have the personal qualities it takes to succeed? Lynch lists patience, self-reliance, common sense, a tolerance for pain, open-mindedness, detachment, persistence, humility, flexibility, a willingness to do independent research, an equal willingness to admit mistakes, and the ability to ignore general panic. Notice that among these traits, a high level of intelligence is not found – you don’t have to be a genius to succeed at investing.
The message of this entire portion of the book can be summed up in three words: do your homework. Sure, you should seek out inspiration for companies to look into from your day to day life – companies you observe doing good business and attracting strong positive word of mouth – but once you’ve identified companies, it’s time to dig in and do the research.
What kind of research? Lynch literally goes on for a hundred pages on the research one should do before investing. Basically, learn everything you can about the company – what their balance sheet looks like, who their management team is, how they compare to similar companies, and so on. Here are five big positive signs to look for, those these just scratch the surface:
– A low price-to-earnings ratio, especially as compared to similar companies
– A low percentage of institutional investors
– Insiders buying the company’s stock
– The company buying back its own stock
– A low debt-to-equity ratio, especially as compared to similar companies
Even if you’ve found a stock that looks really good according to the numbers, don’t invest just because of the numbers. Make sure you can describe why this business is a good business and why you’re buying this stock – and the fact that the stock is going up is not a good reason.
My favorite tip? The second you hear people on CNBC announcing that your sector of interest is “hot” or that the specific stock you own is “hot” is the exact second to start thinking seriously about selling the stock. Lynch all but says to do the exact opposite of what the analysts are saying, particularly in the media – the hot stocks are a bad idea, but the boring stocks are a good idea.
I really am just scratching the surface here. The amount of real meat in this section to dig into if you’re into individual stock investing is quite amazing.
The Long Term View
So, now that you have the tools to identify a stock, what next? The final section discusses assembling a portfolio, knowing when to sell and when to buy, and that conventional wisdom here, once again, is often bogus. Here are five of the best tips I pulled out of this section.
Sell the second that your reason to own the company changes, but not a second before. Don’t just sell to take gains – if your reason for owning the company is still true, you’re probably just guaranteeing that you’ll miss out on some additional gains. Along the same lines, you should know exactly what your reason for ownership is and know what exactly constitutes a change in that reason. If you own because of the owners, sell when the ownership changes, for example.
Buy when everyone else is selling (i.e., when the market is down). This just means that the market decided to put stocks on sale. Take advantage of that sale.
Be patient. As long as your fundamental reasons for investing don’t change, don’t get impatient. Sit on that stock. Sometimes it takes years for a stock to truly take off.
Don’t buy a company you don’t believe in just because the stock is a value. Lynch’s take on the value investing concept is that you shouldn’t just buy because a stock seems cheap – you should believe in the company with sound reasons backing up that belief. Don’t just blindly follow the numbers.
The single best tip of all: “If you can’t convince yourself ‘When I’m down 25 percent, I’m a buyer’ and banish forever the fatal thought ‘When I’m down 25 percent, I’m a seller,’ then you’ll never make a decent profit in stocks. In other words, don’t invest in a company unless you have a compelling reason to invest – and believe in that reason.
Buy or Don’t Buy?
This is perhaps the most thorough and enjoyable book I’ve read on individual stock investing, surpassing my previous favorite on the topic. It is a thorough grounding in what to look for when picking an individual company to invest in – and what those investment numbers actually mean. Best of all, it’s all wrapped up in Lynch’s writing style, which is quite good and very absorbing.
Some of the specific examples in this book are a bit dated, but with just a bit of work using online tools like or clever Google searching, you can basically recreate the examples using current stocks. Better yet, when you do that, you find out that the strategies still work like a charm – for instance, when I first started utilizing the information in this book, I picked Apple (AAPL) at 94. It proceeded to break 200 within six months.
If you have any interest in individual stock investing at all, read this book. It’s well worth it – and it’s earned a coveted place on my permanent bookshelf – not many books do.