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How Peter Lynch found 10-Baggers and Differed from the Rest
Peter Lynch was the manager of the Magellan fund at Fidelity Investment between 1977 and 1990. With an average annual return of over 29%, he was the best-performing mutual fund manager globally and managed to increase the assets under management from $18 million to $14 billion.
Although he is considered a value investor, his investment approach is quite unique among his colleagues.
One difference stands out in particular...
Most successful value investors are advocates of concentrated portfolios.
A few big positions. Charlie Munger propagates the term "Diworsification," which describes the process of limiting your performance by diversification.
Peter Lynch, however, was known for his “excessive” diversification. At his beginning at Fidelity, his boss told him to reduce the positions of the Fund he was taking over from 40 to 25. Instead, he increased them to 60. At some point in his career, he held over 1,400 positions in his portfolio.
Instead of focusing on just four to five companies and betting big on them, Lynch invested in many companies if they offered great and stable fundamentals with reasonable growth expectations. Of course, some of them still failed, but on average, healthy companies with steady growth will come out on top.
So for every loser in his portfolio, there were five to six companies he made money on.
But Lynch didn't diversify that excessively because he thought it was necessary for safety. It was just a by-product of another investment characteristic of his. We'll talk about that one later on.
2. Everyday Companies
When finding investments, Lynch was a fan of looking for everyday companies. A famous investment for him, for example, was Dunkin' Donuts. So wherever he was, in a restaurant, a shop, or some other place, he asked if that company was public and, if so, glanced at their balance sheet and income statement.
This was a great way to find new investment opportunities, and he experienced firsthand how the company worked and how customers responded. Lynch says that there is nothing easier than sitting in a restaurant and seeing how many people go inside and with what emotions they leave the store.
Research that is often underrated. Phil Fisher used a similar approach which he called the Scuttlebutt approach. I’ll release an article digging deeper into that soon.
The best investments are strong brands that customers love and would return to any time.
This approach for finding new possible investments also came with the following advantage.
Ten baggers are investments that return you ten times your money. Peter Lynch searched for exactly such companies. But a company with the chance to become a ten-bagger must fulfill some criteria.
1. You Got to Be Early.
No matter how great the company is, your investment won't tenfold if you're too late.
Apple is one of the most outstanding companies in the world, but with a market capitalization of almost 3 trillion dollars, a tenfold is nowhere in sight.
2. You Have to Hold The Investment
Many companies tenfold at some point in their lifetime, but even when you bought in early, chances are, you already sold when you tripled your money.
Nicholas Sleep (Nomad Investment Partnership) once wrote a great letter telling the story of Walmart.
Walmart is the world's largest company by revenue, and the stock increased from less than one cent to over $140. Yet, the founder's family was the only one who actually held the stock without selling it the whole time.
Most people fail to hold the stock long enough to get a ten-bagger.
Peter Lynch's two investment strategies above both benefited him greatly on his hunt for ten baggers. Diversification provided two advantages. First, he had plenty of options for possible ten baggers. And second, he had so many stocks that it wasn't hard not to sell since he didn't even remember every one of them, and his net worth wasn't in danger when one of them got in trouble. Bad news couldn't scare him.
His "everyday company" approach also allowed him to find great businesses before they experienced significant growth and market capitalization.
4. The More Stocks You Research, The More Investments You'll Find
Sometimes, the market seems overvalued, and investment opportunities are rare. Yet, even then, it's unlikely that you won't find suitable investments if you look across all kinds of branches and markets.
The more stocks you research, the more investment opportunities you'll find. This will always be true.
Peter Lynch was known for researching thousands of companies. Otherwise, he would never have had such a large portfolio. It wasn't solely for the purpose of diversification. No one needs 1,400 stocks to be well-diversified.
He simply analyzed so many companies that it was inevitable that he found hundreds of companies that fulfilled his investment criteria.
And because he never invested a substantial amount of the funds' money into a single holding, it was no problem when some stocks did not turn out as he planned.
And many of them did not, as he often emphasizes in his speeches or books.
In the end, Peter Lynch's completely different investing approach beautifully shows that there are many ways to successful investing and that nothing, neither a very concentrated portfolio nor a very diversified one, is inherently good nor bad.
All that matters is the quality of the companies you invest in.
That’s it for today!
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