The Peter Lynch formula for investing success

• Know the business, don't worry about the stock price.

• Use PEG for reasonable entry values.

• Falling markets are a great advantage to a stock picker.

• Be patient you only need 2 or 3 great wins in your lifetime.

Peter Lynch is considered to be one of the greatest investors of all time and undoubtedly the greatest mutual fund manager of all time. His track record at Fidelity produced a 13 year compound record of 29.2% doubling the returns of the S&P. Yet despite his astounding results his approach is imminently accessible and simple to understand. So in this age of options, cryptos, futures and forex - all of which promise quick riches on levered basis it’s interesting to examine how an old fashioned stock picker was able to find many ideas that returned 3X, 5X,10X their initial investment value.

In this 1994 lecture in front of the National Press Club Lynch provides a clear guide to his investment approach that has been the cornerstone of his success.

Know what you own

Lynch’s number one rule is that you must clearly understand the company’s business and understand why their product and service will enjoy acceptance in the marketplace. Most people own stocks because they are going up. As Lynch says, “a stock is not a lottery ticket”. Don’t guess on the value of the stock price rising, rather bet on the prospects business doing well.

Why do stocks rise in price?

For Lynch the stocks rise in price is simple. The company makes more money over time. He gives the example of Coke which increased its earnings 30 fold in 30 years and the stock rose by 30X. In fact that this is the best way to understand the Lynch investment process. If you believe that a specific stock will have 10X more sales 10 years from now then it would make the perfect Lynch investment vehicle.

How to buy at a reasonable value?

Since Lynch was always looking for strong growth companies he could not use the traditional Price Earnings ratios as means for valuation because the markets would often bid those stocks up on expectations. So he created a metric called PEG which stood for Price Earnings Growth.  The idea was that if a company was growing at 15% per annum then 15 P/E was a reasonable price to pay for the stock.  It’s a simple shortcut that ignores many macro fundamentals but that was precisely the point. It was used as a rough measure to make sure that the investor did not grossly overpay for a stock ( for example buying a stock at 50 P/E for a company that was growing at only a 10% rate).

Stock markets will always fall - use it to your advantage

Lynch notes that in the last 93 years there have been 50 declines of 10% or more and 15 declines of 25% or more. That means that every six years the equity market could be at least a third of its value. This is a great time to add to the positions that you like since the business prospects of a company are not dependent on the stock price but on the strength of its product or service , a sharp drop provides an even better opportunity to triple or quadruple your money over the long run.

Be patient you only need 2 or 3 five baggers in your lifetime

Lynch makes the point that you only need a couple of great stocks that triple or quintuple in order to achieve lifetime investment goals. He notes that those results take time and says that his best stocks did not perform in the 5th or 6th day or month of ownership, but in the 5th or 6th year. In other words the true parabolic rise in stock prices of high growth companies takes at least 5 to 7 years to actualize so be patient with your holdings and as long as business performance remains on track hold your position irrespective of market swings or stock oscillations.