Legend Profile - Peter Lynch
The second profile in the investor legend series is Peter Lynch. Peter Lynch is most noted for managing a fund called the Magellan Fund at Fidelity Investments in the United States. This particular fund of money was the best performing mutual fund in the world between 1977 and 1990 thanks to Peter Lynch. He averaged an astounding 29.2% annual return. Some of the higher achieving stocks in this fund over his tenure included: Ford, Volvo, General Electric, Kemper and Lowe’s. Peter Lynch is also the author of some well-known investing books: One Up on Wall Street, Beating the Street and Learn to Earn.
His investing philosophy shares a lot in common with other legends, including Benjamin Graham who was profiled on the site last week. Once again, the “invest in what you know” viewpoint comes into play with Peter Lynch. Variations on this theme have been noted throughout this site and in the articles. I love this approach because it is something everyone can do. You do not need degrees or tons of education to utilize this principle in your investment strategy. He encouraged individual investors to examine investments around them – where they work, what they buy at the grocery store, what their kids are interested in purchasing, what they observe in the world around them in terms of trends, etc. Peter Lynch deemed this type of investigation “local knowledge” or the “story” approach to investing. You are figuring out what the “story” is on a particular company and where it is likely to head based on your “local knowledge” which is most often much better knowledge than that of an advisor or expert with no such knowledge. Part of learning the story was also looking at the company's fundamentals more closely once you decided on a potential pick.
Peter Lynch categorized companies for consideration into six categories: slow growers, stalwarts, cyclicals, fast growers, turnarounds and asset plays. Slow growers are the least preferred among the six presented as they have the least opportunity for growth. While they may be in a position, given their stability, to pay a dividend, don’t expect much astronomical growth as that time has most likely passed for the company. Like slow growers, stalwarts are also large, well established companies but the key different is that they are still growing. An oft-cited example of this type of company is Pepsi Co. Cyclical companies rise and fall with the economy. An excellent example of a cyclical company would be those operating in the oil and gas or energy sectors. As is evident for anyone living in oil and gas heavy economies, cyclicals can be very hard companies to time one’s investment. The companies are large, well established companies but their stock prices are tied to the ups and downs of the commodity cycle and if you don’t time the cycle correctly, you can lose a lot of money. It is easy to see how an inexperienced investor could suffer losses when wrapped up with cyclical companies. Peter Lynch has said cyclical’s are the most misunderstood of all stocks as they often appear to be stalwart's but due to the cyclical nature of their industry, they are not. Fast growers are just as they sound – new and small companies that grow typically more than 20% per year. If the fundamentals are in place on a fast-growing company, it would be a perfect pick for Mr. Lynch. Fast growers also carry with them the most risk. Turnaround companies are those that were once strong but have suffered a large fall. A good example of this would be Chrysler during the time it was suffering significantly. It since rebounded and became a good stock despite its prior troubles. Finally, asset opportunities are companies that analysts and experts have overlooked or missed. These are prime opportunities for one to use their "local knowledge" as they have the inside scoop into whether something makes a good investment or not. It is based on information Wall Street is not privy to but you, as an individual investor, have a front row seat given your position as an employee or general consumer.
In terms of metrics, Peter Lynch considers a few ratios as particularly informative. With respect to earnings growth, the growth should fit with the story of the company. Is it a fast grower or a slow grower? The earnings profile should fit accordingly. He also considered the P/E ratio which has been discussed at length on this site in various posts. This price/earnings ratio indicates whether the market has over or underpriced the stock. Peter Lynch suggested the company’s P/E ratio should equal its earnings growth rate. If the P/E is less than the growth rate, it could be underpriced and worth serious consideration. Peter Lynch also closely monitored the ratio of debt to equity of a company. He was interested in investing in companies with lots of cash and little debt. This is more or less just common sense! In terms of dividends, Peter Lynch prefers small, fast growing firms that often do not pay a dividend. However, for those dividend-paying companies, he advocates examining the ability to pay the dividend during recessionary times. If the company can continue to do that in tough times, it is obviously doing something correctly. Finally, like many other legend investors, Peter Lynch considered the company buying back its shares as a very positive sign. We have also discussed this many times on the site but again, the fact a company is buying back its own shares most often means they feel they are undervalued. You should take cues from this sign!
Peter Lynch is another legend investor that can teach us all a great deal about investment strategy. His approach is not complicated and in keeping with general sentiment on this site - invest in what you know and are interested in learning further about. Most likely you are in just a good of position to know what is on trend or a good business based on how you spend your money and time. If you are interested, you can take the next step of learning how to dig deeper into the particular company to get a sense whether it is a good investment or not.
** Top photo courtesy of Anders Jilden on Unsplash