Investment Strategies

Investment Style

Often described as a "chameleon", Peter Lynch adapted to whatever investment style worked at that time.
His secret was a punishing work schedule, lasting six and sometimes seven days a week, in which he
talked to dozens of company managers, brokers and analysts every day. With a total staff of just two
research assistants, he ran a portfolio of up to 1,400 stocks at any one time. Some he bought at an early
stage of growth or recovery and held for years.
Apart from this punishing work ethic, Lynch did consistently apply a set of eight fundamental principles
to his stock selection process. According to an article by Kaushal Majmudar, a CFA at The Ridgewood
Group, Lynch shares his checklist with the audience at an investment conference in New York in 2005:

Know what you own.

It's futile to predict the economy and interest rates.
You have plenty of time to identify and recognize exceptional companies.
Avoid long shots.
Good management is very important - buy good businesses.
Be flexible and humble, and learn from mistakes.
Before you make a purchase, you should be able to explain why you're buying.
There's always something to worry about.

In picking stocks (good companies), Peter Lynch stuck to what he knew and/or could easily understand.
That was a core position for him. He also dedicated himself to a level of due diligence and stock research
that left few stones unturned. He shut out market noise and concentrated on a company's fundamentals,
using a bottom-up approach. He only invested for the long run and paid little attention to short-term
market fluctuations.
Lynch is adamant that any small investor can research stocks better than most professionals, and make
smarter decisions about what to buy. This is because he or she is often better placed to spot potentially
profitable investments early, and is always free to act independently, rather than constrained by
committees, trustees and superiors.
Peter wrote several books outlining his philosophy on investing. They are great reads, but his core thesis
can be summed up with three main tenets: only buy what you understand, always do your homework
and invest for the long run.
1. Only Buy What You Understand
According to Lynch, our greatest stock research tools are our eyes, ears and common sense. Lynch was
proud of the fact that many of his great stock ideas were discovered while walking through the grocery
store or chatting casually with friends and family. We all have the ability to do first-hand analysis when
we are watching TV, reading the newspaper, or listening to the radio. When we're driving down the street
or traveling on vacation we can also be sniffing out new investment ideas. In other words, most of the
stock market is in the business of serving you, the individual consumer - if something attracts you as a
consumer, it should also pique your interest as an investment.

2. Always Do Your Homework

First-hand observations and anecdotal evidence are a great start, but all great ideas need to be followed up
with smart research. Don't be confused by Peter Lynch's homespun simplicity when it comes to doing
diligent research rigorous research was a cornerstone of his success. When following up on the initial
spark of a great idea, Lynch highlights several fundamental values that he expected to be met for any
stock worth buying:

Percentage of Sales: If there is a product or service that initially attracts you to the company,
make sure that it comprises a high enough percentage of sales to be meaningful; a great product
that only makes up 5% of sales isn't going to have more than a marginal impact on a company's
bottom line.
PEG Ratio: This ratio of valuation to earnings growth rate should be looked at to see how much
expectation is built into the stock. You want to seek out companies with strong earnings growth
and reasonable valuations - a strong grower with a PEG ratio of two or more has that earnings
growth already built into the stock price, leaving little room for error.
Favor companies with a strong cash position and below-average debt-to-equity ratios.
Strong cash flows and prudent management of assets give the company options in all types of
market environments.

3. Invest for the Long Run

Lynch once conducted a study to determine whether market timing was an effective strategy. According to
the results of the study, if an investor had invested $1,000 a year on the absolute high day of the year for
30 years from 1965-1995, that investor would have earned a compounded return of 10.6% for the 30-year
period. If another investor also invests $1,000 a year every year for the same period on the lowest day of
the year, this investor would earn an 11.7% compounded return over the 30-year period.
Therefore, after 30 years of the worst possible market timing, the first investor only trailed in his returns
by 1.1% per year! As a result, Lynch believes that trying to predict the short-term fluctuations of the
market just isn't worth the effort. If the company is strong, it will earn more and the stock will appreciate
in value. By keeping it simple, Lynch allowed his focus to go to the most important task finding great
companies.
Methods and Guidelines

Keep your eyes and ears open for ideas

Lynch's key concept is that you can spot investment opportunities all around you, if only you
concentrate on what you already know and are familiar with. Among your best sources of
information are:
-Your job (your company, its customers and its suppliers)
-Your hobbies and leisure pursuits
-Your family and friends (their jobs and hobbies)
-Your observation and experience of companies in your home town.

Categorize your ideas

Companies can be categorized into 6 main types:

1. Slow growers - raising earnings at about the same rate as the economy, about 2-4% a
year.
2. Stalwarts - good companies with solid EPS growth of 10-12%
3. Fast growers - small, aggressive new companies growing 20-25% or more.
4. Cyclicals - whose earnings rise and fall as the economy booms and busts
5. Turnarounds - companies with temporarily depressed earnings, but good prospects for
recovery.
6. Asset plays - companies whose shares are worth less than their assets, provided these
assets could be sold off for at least book value.
Consider concentrating your efforts on finding fast growers. If bought at the right price, some of these can
become 'tenbaggers' - shares that multiply your investment ten times over. Otherwise, look for
turnarounds and perhaps the occasional asset play. Try to avoid holding cash. It is better to stay fully
invested by putting any spare money into stalwarts. That way, you will not miss out on rising markets.
Avoid slow growers (too unprofitable) and cyclicals (too hard to time).

Summarize the story behind your stock

Prepare a 2-minute monologue about the stock you have in mind, describing
The reasons you are interested in it
What has to happen for the company to succeed
The obstacles that might prevent its success.
This is the stock's 'story'. Make sure it is simple, accurate, convincing, and appropriate for the
category of stock in question. For example, 'if it's a fast grower, then where and how can it
continue to grow fast?'

Check the Key Numbers

1. If you are excited by a particular product or service, check it accounts for a sufficient
percentage of total sales to make a significant difference to profits.
2. Favor companies with a forecast P/E ratio well below their forecast EPS growth rate (i.e.
a low PEG ).
3. Favor companies with a strong cash position.
4. Avoid companies with a high debt-to-equity ratio ('gearing'), especially if the debt takes
the form of bank overdrafts, which are repayable on demand, rather than bonds, which
are not.
5. In the case of stalwarts and fast growers, look for a high pretax profit margin. In the case
of turnarounds, look for a low one with the potential to rise.

Base your buy and sell decisions on specifics

Your profits and losses do not depend on the economy as a whole. They depend on the factors
specific to the stocks you hold. So ignore the ups and downs of the market. Buy whenever you
come across an attractive idea, with a compelling story behind it, at an attractive price.
Consider selling stalwarts when their PEGs reach around 1.2-1.4, or when the long-term
growth rate starts to slow.

 Consider selling fast growers when there appears to be no further scope for expansion, or
expansion starts to produce only disappointing sales and profits growth, or when their
PEGs reach around 1.5-2.0.
Consider selling asset plays when they are taken over, or when assets that are sold off
fetch lower than expected prices.

http://www.investopedia.com/university/greatest/peterlynch.asp#ixzz41zGidcfc
http://www.incademy.com/courses/Ten-great-investors/Peter-Lynch/6/1040/10002
http://www.investopedia.com/articles/stocks/06/peterlynch.asp