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How did Peter Lynch make his money?

Peter Lynch

Investing is simple, but often, it is complicated and challenging for beginners. This blog will cover the strategies of one of the US’s most successful fund managers – “Peter Lynch”. Most of you would have heard his name in stock market free webinar or stock market courses online free with certificate. He makes investing so straightforward that somebody from 5th and 7th grade can understand. So, let’s learn some more about Peter Lynch and how did Peter Lynch make his money?

For 13 years, Peter Lynch was the fund manager of Fidelity Magellan Fund. He gave the fund an astonishing return of 29% on a year-on-year basis. Not just that, his managed fund beat its benchmark, the S&P 500, in 11 of the 13 years in 1977-1990. During his 13 years at Fidelity Fund, he grew the firm’s assets from $18 million to $14 billion (as of 1990). He has an investment understanding, and his achievements are a testament to that. So, let’s learn about his investment strategy and stock-picking style and understand how did Peter Lynch make his money?

Investment Strategy

Pick up what you understand: “Know what you own” is Lynch’s investment mantra!

Peter Lynch strongly believes that the things that help us the most in investing are our eyes, ears, and common sense. He believes that all humans can analyze things correctly, and we all do that daily, whether driving on the road safely, guessing what happens next in a TV show, etc.

He believes if one is unable to explain what a company does in 30 seconds or lesser, they should not own it. This could be said about any investment avenue. Be it any stock, Insurance, Mutual Funds, or any other financial product, you should put money into it only when you fully understand how it works and what risks it carries. So before asking how did Peter Lynch make his money, one must ask the following questions:

Have you met the owner of any business?

Have you asked them how their business runs?

A business owner can tell you quickly how his business functions. He will paint a picture before you as if drawing with a crayon. Investing in any company is like becoming an owner of that company. Hence, if you do not understand the business as the owner understands it, do not invest in it. If you invest in a business you don’t understand, you will never know the company’s true potential. Let’s take the Insurance business as an example. Although Insurance as a product is simple to understand, understanding Insurance as a business is one of the most complex businesses to understand.

The metrics used to analyze this sector are complicated and very different from other sectors. This analysis keeps us away from investing in a company that sells Insurance. This is one of the fundamental aspects in decoding how did Peter Lynch make his money.

Don’t gamble only concentrate on Earnings growth

The answer to how did Peter Lynch make his money lies hidden in Earnings growth. Peter Lynch says, “People are careful when they buy a house, a refrigerator, or a car for themselves. People will work hours to save a hundred dollars on a roundtrip air ticket. They’ll put $5,000 or $10,000 on some bizarre idea they heard on the bus. That’s gambling, but surely not investing. That’s not research, rather just total speculation.”

Lynch believes every stock has an underlying business. When investors purchase a company’s stock, they should feel like they have bought ownership. Therefore, before investing, they should thoroughly research it. If an investor has just put their money hoping that the share price will go up, it is pure speculation and not investing. Following is the shareholding of Yes Bank.

If you check this data, retail has the highest holding. Most of the retail has penny stocks. They consider investing in stocks by concentrating on how much return they can make if these stock prices double but fail to concentrate so much on earnings. An invaluable deduction in how did Peter Lynch make his money comes out as, he never invested in stocks flurried with the retail.

But the prime reason any stock goes up is the explosion in the earnings. For example, Apollo Pipes has offered blockbuster returns of 11000% in the last ten years. It has seen its sales grow from just Rs 68 lakh in FY13 to Rs 784 crore in FY22. Meanwhile, profit after tax (PAT) surged from Rs 36 lakh to nearly Rs 50 crore in the same period.

Staying invested for long

Like most successful investors, Lynch also believes in staying invested for the long term. While decoding how did Peter Lynch make his money, as per him, it is crucial to succeed at investing. As per him, you should dismiss all such forecasts in the news and concentrate on what’s happening to the companies you have invested in.

The economy is dynamic. One day, when you sleep, everything may be expected. But the next day, when you wake up, the economy may be threatened by a world war! Therefore, the economy cannot be predicted. Economic factors are out of anybody’s control, but a company’s performance or factors can be predicted.

Lynch also says that many investors fancy themselves as long-term investors, but only until the next significant drop. At such a point they quickly become short-term investors and sell their stakes for huge losses. This is one significant aspect when one seeks answer to how did Peter Lynch make his money?

Let’s understand how this statement would fit in the Indian context with an example. Assume you invested Rs. 1 lakh in SENSEX around 15 years ago, on April 1, 2006.

DateAnnual Return (%)Annual Return (Absolute)(in Rs.)Total Value Of Investment (in Rs.)Average Annual Return If You Exit After Major Corrections
Apr 1 , 20077.70%7,700.001,07,700.00 
Apr 1 , 200825.46%27,420.421,35,120.42 
Apr 1 , 2009-36.63%-49,494.6185,625.81-6.04%
Apr 1 , 201078.68%67,370.391,52,996.20 
Apr 1 , 20119.77%14,947.731,67,943.93 
Apr 1 , 2012-10.00%-16,794.391,51,149.537.13%
Apr 1 , 20137.93%11,986.161,63,135.69 
Apr 1 , 201418.99%30,979.471,94,115.16 
Apr 1 , 201525.90%50,275.832,44,390.99 
Apr 1 , 2016-10.58%-25,856.572,18,534.428.13%
Apr 1 , 201718.36%40,122.922,58,657.34 
Apr 1 , 201811.18%28,917.892,87,575.23 
Apr 1 , 201916.90%48,600.213,36,175.44 
Apr 1 , 2020-27.30%-91,775.902,44,399.556.59%
Apr 1 , 202177.00%1,88,187.654,32,587.20 
Average Annual Returns If You Stayed Invested For The Entire Period10.30%

Understand at what price you should buy

While looking for the answer to how did Peter Lynch make his money, in his book One Up on Wall Street, he gives a simple, straightforward explanation of one of his preferred metrics for determining a high-level valuation of a firm.

The P/E ratio of any reasonably priced company must equal its growth rate. For example- If the P/E of Britannia is 15, you’d expect the company to grow at about 15% a year, etc. If you find the company’s P/E ratio less than the growth rate, then you have struck a bargain for yourself. A company with a growth rate of 12% yearly and a P/E ratio of 6 is a handsome prospect. On the other hand, a company with a growth rate of 6% a year and a P/E ratio of 12 is an unattractive prospect and headed for a comedown. This is a crucial aspect in figuring out how did Peter Lynch make his money.

Lynch developed the PEG ratio to solve a shortcoming of the P/E ratio. For determining the earnings growth, you can consider its historical earnings growth.

PEG ratio = P/E ratio/company’s earnings growth rate.

Do not keep looking for better investment opportunities.

As per Lynch, once you buy a stock after a long and thoughtful process, do not keep looking for better investment opportunities. Stock markets are large and complex. Suppose you keep switching from one company to another because the other gives better returns. In that case, you will end up with no actual profits. When we seek answer to how did Peter Lynch make his money, we find that he doesn’t jump from one stock to another.

Imagine you make a new friend because he speaks good French, and you want to learn French. You both become good friends in a week. But after a week, you find that your friend has a neighbour whose French is better than his. So, you leave your friend and go to his neighbour. But you realize his French is too tough to understand when you go there. And now, you cannot return to your old friend because you paid this neighbour to learn French.

You get trapped in similar situations when you keep looking for better stocks. Once you have decided, trust it to work for you unless there are fundamental changes in the company.

How does Peter Lynch Classify different types of business?

Slow Growers

These stocks are usually large and ageing companies that were previously fast growers but now have retarded down, e.g., utility stocks. These companies have earnings growth comparable to GDP growth. Such stocks are an excellent pick for the vision of dividend investing. Of course, one must check parameters like dividend history, dividend payout ratio, etc. While looking for answer to how did Peter Lynch make his money, we found he invested into such stocks.

The utilities sector is an industrial category of stocks, consisting of companies that provide basic everyday amenities, including natural gas, electricity, water, and power

Stalwarts

They are not high-growth companies, but they grow faster than slow growers. They are unlikely to go out of business, e.g., HDFC Bank and Reliance. Their earnings growth rates are near 10-12% per year.

While investing in such companies, investors should buy only at a reasonable P/E. Also, investors should check if the company can maintain a similar growth rate. Lynch strives to buy low and to sell with a 30-50 % gain after 1-2 years as per his strategy. These companies offer good protection during recessions and economic downturns. As per good stock market training institute one should keep a significant stake in such stocks.

Fast Growers

These stocks are small capital, aggressive new enterprises that have the potential to grow 20-25% per year. Investors can become multi-baggers if they research and choose these companies wisely. While analyzing these stocks, investors should look for fast growers with a solid balance sheet making substantial profits and buy them at a P/E near or around their growth rate. Also, they must understand the company’s future growth prospects and see if it still has room to grow and expand. While seeking answer to how did Peter Lynch make his money, we found he invested in good proportion into such stocks.

Cyclicals

These companies’ sales and profits rise and fall in cycles, and their growth depends on macroeconomic factors—for example, autos, airlines, steel, etc. One should invest in them when the economy is coming out of a recession and transcending into a vigorous economy. When investing in cyclical stocks, timing is everything. Investment in cyclical sectors is also taught in the best stock market courses.

Turnarounds

Markets would have beaten down these companies due to their failures, but they still have the potential to turn their business around. While investing in such companies, investors should analyze the company’s debt. High debt implies a high chance that the company may go bankrupt. Further, investors should see the management’s plan to turn around the business and then consider investing in them. Best stock market courses in Delhi coach you how to find such stocks.

Asset Plays

These companies have considerable assets on their balance sheet but are unnoticed by other investors. While investing in them, investors should see if the company has debt that can set off the assets. Also, investors should see if the company plans to take on any new debt, which could be analyzed from the company’s annual reports.

How can we pick stocks like Peter Lynch?

When we answer to how did Peter Lynch make his money,you might also think, if there’s a way to pick stocks like him too. If we want to choose the fast-growing companies in Peter lynch way, then we can use following criteria:

  • Market Capitalization should be more than Rs 1000 Cr and Less than Rs 15000 Cr
  • Sales growth for 5 Years should be greater than 20%
  • Profit growth for 5 Years should be greater than 20%
  • PEG Ratio should be less than 1 times
  • Debt to equity should be less than 0.50 times.

You can check the dynamic link of such stocks here!

Conclusion

Peter Lynch’s strategy seems quite simple on the surface, but as they say simple things are hard to follow in the market. He follows a buy and hold strategy, where he knows what he buys and sticks to the company in the long term. This is our research for the answer to how did Peter Lynch make his money. Investing in good stocks is extremely important and if one’s inexperienced, then they could go for Top 5 Online Stock Market Courses in India.

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