Peter Lynch is a legendary investor who achieved a 29% CAGR during his 13-year tenure at Fidelitys Magellan fund. He bought thousands of stocks, and eventually got a reputation for never having met a stock he didnt like.
But in reality Lynch didnt like a lot of stocks, and he had a set of rules he lived by. These rules kept him on the straight and narrow and made him one of the worlds best fund managers of all time.
Never invest in a idea that you cant illustrate with a crayon
Peter Lynch believed, just like Warren Buffett, that nobody should be investing in things they dont understand fully. And the only way you know you can understand it fully, according to Lynch, is if you can illustrate it with a crayon.
When were investing in companies with our hard earned cash, its of paramount importance that we know what were investing in, and we know how the company were investing in makes its money.
If we dont, then were putting ourselves at risk. Naturally, if youre a tech veteran, then youre going to have an edge in understanding new technologies and their importance in the economy. And if youre a retail buyer, your expertise is going to be in brands and fashion. By utilising our edge and being able to draw the investment case, we give ourselves higher chances of success.
Never invest in a company without understanding its finances
Cash flow is everything. How a company manages its cash is more important than profit. What does the balance sheet look like? Is it backed by strong and sturdy assets like cold hard cash, or is it riddled with intangible assets?
What does the liabilities section look like? Is there a large loan that needs paying off in current assets or is it bank debt that matures several years away?
The financial statements are the most important part of any investment decision, and if you dont understand these at a basic level you are putting yourself at risk.
Long shots almost always miss the mark
Theres a reason a horse is marked as 100/1. Its because its not expected to win. But every now and again, the outsider wins enough to keep the punters dreaming and coming back to give away all of their gains.
Story stocks are usually big on dreams but fall short in reality. They talk a good game, but the proof is never in the pudding or in the financial statements. Dont listen to what the directors say look at what they have done for the company.
Lynch may have retired nearly 30 years ago now, but his advice remains as timeless as ever. By avoiding mistakes we give ourselves the best chances of success to compound our capital over the long term.
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