From the Masters (3): Peter Lynch - World's Most-famous Mutual Fund Manager

It's good to understand, straight away, that in running a mutual fund, Mr Peter Lynch was simply investing and largely in stocks - picking stocks, buying stocks, selling stocks. In distinguishing himself as an outstanding fund manager, he just proved himself to be one of the front-running stock investors of our time. This article is both a tribute to his accomplishments and another attempt to glean from the strategies of one of the most successful market players of recent memory.

Mr Lynch took an early retirement (at 46) in 1990, after some 13 years at the helm Fidelity Investment's Magellan fund, in USA. He joined Fidelity in full employment in 1969, became director of research 1974 - 1977 and was appointed to head the Magellan Fund (a mutual fund), in 1977. Two features easily defined the quality of his performance in that relatively short period: (1) the fund grew from a modest $20 million (some accounts say $18 million) when he commenced in 1977, to a whopping $19 billion at his exit in 1990; (2) the fund beat the S&P 500 index in earnings in 11 out of the 13 years, turning in an average return of 29.2%, exceptional for the US market. When you begin to talk about stock market gurus, be sure to include this man who recorded a remarkable performance that has earned him so much respect in this field.

"But what has success in the American stock market got to do with my investing in Nigeria", you may ask. Firstly, you are not really restricted to investing on the Nigerian Stock Exchange. As an investor, you can invest globally. Secondly, while the nuances of market behaviour may vary a bit, investor sentiment, which rules the markets, tends to have common threads. Also the companies whose stocks are traded face similar challenges of business success and delivery of investment returns. Financial statements, which report operational results, are drawn on similar principles and the various ratios and factors that matter to investors in one market are as important in another. So, mastering what strategies these pros have used, even in the US market, can equip you to accomplish excellent results, in our own market. What then was the core of Lynch's investing strategy? From his books, interviews, articles and speeches, some key points of his system have been extracted:

• Be in Familiar Territory
  This was encapsulated in his phrase "invest in what you know", a principle that has also been important to Warren Buffett, who never invested in companies he didn't understand their business. Lynch has further posited that identifying great investment opportunities doesn't have to result from massive quantitative analysis and other sophisticated evaluations. Ordinary folks, if they remain alert to developments around them, he says, can spot emerging or hidden opportunities - the diamond in the rubble - before the market, dominated by big fund managers and institutional investors, gets into the picture. Great products are used by the people. Factories are built in people's neighbourhoods. Important facts that point to successful business performance for a company can be picked up by investors who have their feelers up. Given the limitations that fund managers may have - often for control purposes, a straight-jacketed list of approved high-profile stocks is provided by the organisation to guide their investing actions - the individual investor may have an edge in moving into stocks that represent huge value, though still uncelebrated. Obviously, if you get it right a few times, by positioning in a stock before the big players get in on the act, you will readily hit the bull's eye, knowing that these major investors will price up the stock when they discover and swoop on it. If you choose to buy after they have popularized a stock and bid up it's price, you clearly limit the opportunity to make massive gains. The question is whether you will think like an investor when you see or hear things concerning companies, especially the less glamorous ones. Quickly think of the investment implications of the things you get to hear or know about companies and their businesses.
• Proper Analysis Still Counts
  Lynch cut his teeth as director of research, so he has never discounted the need for deep analysis, especially to confirm your initial instinct about a stock. "Investing without research", he has said, "is like playing stud poker and never looking at the cards." Identify seemingly good companies, but check out the key drivers of sustainable performance to see if they add up. The price-earnings-growth (PEG) ratio is one he considers critical. It boils down to strong earnings growth at relatively low valuation, for a great buying opportunity. Sales performance, cash flow and leverage are also key considerations. So is good management. This is summarised in his admonition that before you buy, you should be able to explain why you're buying a particular stock. Well, it should be obvious here that listening out for what stock is making the waves now doesn't fit into this. Every guru emphasises having some parameters you subject your buys to. Are you developing any? One key one is significant earnings growth, especially over some quarters running.
• Categorisation to Manage Selections
  He created categories to sort stocks for evaluation, with clear qualifying criteria for each category. Fast-growers, stalwarts and slow-growers meant different expectations but a stock could get into his portfolio if it fitted into a category. It's all about defining one's buying criteria.
• Mistakes Will be Made
  Mr Lynch accepts that he made mistakes, many times buying stocks that he shouldn't have bought. It only needs the flexibility to accept errors, take appropriate action (like selling off), learn from the mistakes and move on. If such mistakes didn't stop him from hitting the pinnacle of the trade, they won't stop you if you learn to manage your errors. But take action, all the same, since failing to invest, just to avoid errors, equally rules out the big wins.

• The Long-term View Pays Most
  "Stocks are relatively predictable over 10 - 20 years" he has said. The corollary is that pre-occupying yourself with short-term price fluctuations is an unnecessary irritation. Some bit of buy-and-hold strategy, you would say, but Lynch sold when he thought there was a clear error. His research didn't support timing the market or too much of reading the economy. He rather zeroed into individual stocks and, if they had the ingredients he considered necessary for a market-beater, he went for it.

Well, Mr Lynch worked as a professional fund manager, but you are not one. Does that imply that you cannot use the principles that worked for him in that role? He thinks you can do even better, as an individual investor. That's because you have more leaway to get into stocks that haven't yet shone for fund managers and institutional investors, who run highly-guarded funds, to get attracted. It's in such stocks that huge profit potentials may stay locked up, waiting to be unearthed. Why not challenge yourself to really be well-positioned in a couple of stocks, before big buyers find value in them? When that happens, you can be sure of a huge return.