Legendary American investor Peter Lynch shared five rules everyone can follow when investing in the stock market.
Within his 13-year tenure, Lynch drove the Fidelity Magellan Fund to a 2,800% gain – averaging a 29.2% annual return. It is the best 20-year return of any mutual fund in history.
He is considered the greatest money manager of all time, and he beat the market for so long through buying the right stocks.
No one can promise you Lynch’s record, but you can learn a lot from him, and you don’t need a billion-dollar portfolio to follow his rules.
Lynch’s five rules for any investor in the stock market are listed below.
1. Know what you own
The most important rule for Lynch is that investors should know and understand the company they own.
“I’m amazed at how many people that own stocks can’t tell you, in a minute or less, why they own that particular stock,” said Lynch.
He added that if the only reason that comes to mind is that it’s going up, you’re gambling your money away.
Investors need to understand the company’s operations and what they offer well enough to explain it to a 10-year-old in two minutes or less. If you can’t, you will never make money.
Lynch believes that If the company is too complicated to understand and how it adds value, then don’t buy it.
“I made 10 to 15 times my money in Dunkin Donuts because I could understand it,” he said.
2. Don’t invest purely on other’s opinions
People do research in all aspects of their lives, but for some reason, they fail to do the same when deciding on what stock to buy.
People research the best car to buy, look at reviews and compare specs when buying electronics, and get travel guides when travelling to new places – But they don’t do the same due diligence when buying a stock.
“So many investors get a tip on a stock travelling on the bus, and they’ll put half of their life savings in it before sunset, and they wonder why they lose money in the stock market,” Lynch said.
He added that investors should never just buy a stock because someone says it is a great buy. Do your research.
3. Focus on the company behind the stock
There is a method to the stock market, and the company behind the stock will determine where that stock goes.
“Stocks aren’t lottery tickets, there’s no luck involved. There’s a company behind every stock; if a company does well, the stock will do well – It’s not complicated,” Lynch said.
He advises that investors look at companies that have good growth prospects and is trading at a reasonable price using financial data such as:
- Balance Sheet – No story is complete without a balance sheet check. The balance sheet will tell you about the company’s financial structure, how much debt and cash it has, and how much equity its shareholders have. A company with a lot of cash is great, as it can buy more stock, make acquisitions or pay off its debt.
- Year-by-year earnings
- Price-to-earnings ratio (P/E) – relative to historical and industry averages.
- Debt-equity ratio
- Dividends and payout ratios
4. Don’t try to predict the market
Trying to time the market is a losing battle. One thing to keep in mind is that you aren’t going to invest at the bottom. Buy stocks because you want to own the business long-term, even if the share price decreases slightly after you buy.
Instead of trying to time the bottom and throwing all your money in at once, a better strategy is gradually building your stock positions over time.
This approach spreads out your investments and allows you to buy into the market at different times at varying prices that ideally balance each other out versus investing one lump sum all at once.
This way, if you’re wrong and the stock continues to fall, you’ll be able to take advantage of the new lower prices without missing out.
“Trying to time or predict the stock market is a total waste of time because no one can do it,” Lynch said.
5. Market crashes are great opportunities
Knowing the stock market’s history is a must if you want to be successful.
What you learn from history is that the market goes down, and it goes down a lot. In 93 years, the market has had 50 declines; once every two years, the market declines by 10%. of those 50 declines, 15 have declined by 25% or more – otherwise known as a bear market – roughly every six years.
“All you need to know is that the market is going to go down sometimes, and it’s good when it happens,” Lynch said.
“For example, if you like a stock at R14 and drops to R6 per share, that’s great. If you understand a company, look at its balance sheet, and it’s doing well, and you’re hoping to get to R22 a share with it, R14 to R22 is terrific, but R6 to R22 is exceptional,” he added.
Declines in the stock market will always happen, and you can take advantage of them if you know what you own.