Stock up on smart tips

Beating the street Price: Rs 375 Pages: 332 By: Peter Lynch with John Rothchild Published by: Simon & Schuster Paperbacks Target audience: All investors Quick read tip: Designing a Portfolio, a chapter that tells you how to make a stock fund portfolio Language: Easy Style: Illustrative, academic Visuals: Graphs, charts

How often do we get carried away and invest in stocks we know nothing about? More than we’d like to believe. This, according to Peter Lynch, is one of the worst investment ideas. However, one doesn’t have to be a Wall Street professional to be a good investor, and an average person willing to devote some time to researching stocks can make more money than a fund manager. This is the advice belted out in Beating the Street, the anecdotal book by Lynch, the legendary American fund manager for Fidelity’s successful Magellan mutual fund.

Written in 1993, the book travels through 13 years of Lynch’s career, and with 21 principles scattered across the book, reveals the stocks and strategies that enabled him to “beat the street”. The journey begins in 1977, moving through the best years of Lynch’s professional life, and ends with his retirement in 1990.

The initial chapters deal with portfolio allocation and the divide between stocks and bonds, with Lynch arguing in favour of stocks over bonds, saying they are far more profitable. He supports his belief with tables on various portfolio mixes and the best return generators. This may look good on paper, but for people who need regular income, financial planners advise purchasing bonds considering that the markets don’t move up for 20 consecutive years. If you are looking for information on stock funds, go to Chapter 3, which talks about various types of such funds and how it pays to diversify across categories to outperform the market every year. Though not too long, the chapter serves as a good primer, especially in the current market scenario where it helps to know your fund well before exiting it.

The chapters 4, 5, and 6 are a retrospective of Lynch’s early, middle and later years, which trace his steep rise as he helped make a $18 million fund worth $14 billion by the time he retired. Listed out here are the methodology of stock picking, the reasons for the success of the stocks that he bought or didn’t buy, as well as the nuances of the fund’s rising worth. Initially, Lynch churned his portfolio ceaselessly to enable him to profit from new opportunities which, in retrospect, he could have done without; he describes the situation as “pulling out the flowers and watering the weeds”.

Then came the years when he followed a concentrated approach to stock picking, even as he graduated to being a patient investor and held on to positions he believed in for a longer period. In the later years, Magellan grew into a billiondollar fund with over 900 stocks and still managed to outperform other funds, contrary to the belief that a fund is “too big to succeed”.

Lynch’s principles on effective stock picking • Never invest in any idea you can?ft illustrate with a crayon • The extravagance of any corporate office is directly proportional to management?fs reluctance to reward shareholders • The best stock to buy may be the one you already own • If you like the store, chances are you will love the stock • When insiders are buying it?fs a good sign • All else being equal, invest in the company with the fewest colour photographs in its annual report • Gentlemen who prefer bonds don't know what they are missing • As long as you're picking a fund, you might as well pick a good one

Lynch’s 21 principles make for a good lesson in selecting a stock and are supported by examples of companies that he bought or dealt with. In fact, more than half the book— chapters 7-20—is a chronicle of how Lynch went about picking the 21 stocks that he had recommended to the readers of Barron’s—a magazine he wrote for—in 1992. Each chapter deals with a specific company from sectors like restaurant, retail, automobile, chemicals, and beauty and hygiene. Unless you invest in global stock markets, chances are you may not have heard of two-thirds of these companies. Lynch outlines his strategy for buying all kinds of stocks. At the same time he emphasises on checking the stocks every few months and not losing patience when everyone else is selling.

But for a fund manager who took care of billions of dollars, Lynch’s strategy of using logic to understand businesses and invest in them, seems too simple. For instance, he chose a company like Taco Bell because a) he liked the tasty tacos—people will like it, b) 90% of the people had still not been exposed to it—shows potential, c) it had a strong balance sheet— numbers will talk and d) its office was not extravagant— no wasteful expenditure. His logic was that after succeeding in one region with a combination of these factors, chances were that the format would duplicate itself in other cities, thereby increasing the earnings.

Successful stock picking, according to Lynch, can be attributed to how well you understand a company’s business through research, by talking to company representatives, company visits, industry analysis as well as studying the competition. The book comes across as a great read, especially in the current market situation when pessimism is in abundance. Stock picking does not need to be rocket science; it’s a simple matter of how you identify and research stocks.

Lastly, Lynch focuses on the fact that every stock you buy requires a constant follow-up and that no matter how well you know a company, it may not reward you for investing in it. The point has been highlighted from pages 284-304—“the sixmonth check up”— where Lynch reviews each stock in his portfolio and describes the action taken. Also, don’t miss the set of “25 Golden Rules”.

Also read our review of the book The New Buffettology