How to Pick Stocks

Peter Lynch, one of the greatest investors of all time, discusses how he evaluates companies

Author's Avatar
Nov 13, 2017
Article's Main Image

Peter Lynch was one of the most successful investors of all time. As the manager of the Magellan Fund, he produced an average return for his investors of 29.2% between 1977 and 1990, more than doubling the return of the S&P 500 over the same period. Over the period, assets under management within the fund grew from $18 million to $14 billion.

These results indicate Lynch knew how to pick stocks. He imparts some of his investing wisdom in this video, which was taken from an interactive webpage. I have gathered some of the best, most informative quotes from the video and present them in the text below. Hopefully, you will find some of it useful.

How to pick stocks

"If you want to double your money quickly and safely, fold it in half and put it in your pocket. A good stock can take three or five years before it really takes off. It’s not two or three weeks, it’s not two or three months. My best stocks have been my fifth, sixth, seventh year. Give your stocks time to grow."

"Many people ask me, when is the right time to sell a stock? Selling stocks is a matter of comparing stories. If story A is better than story B, then sell B and buy A. If you own eight companies, you are playing eight simultaneous games of poker. So only stay in the games that you have the best chance of success. But remember stories rarely change overnight."

"Even if you have a crystal ball, you probably can't predict a company's earnings. But Wall Street has a whole army of people who make such predictions... If you really understand the company, you should know how it plans to make earnings rise. If you understand its earnings prospects, you should be better able to evaluate the company as an investment. You can't predict the future, you can learn from the past. A company with a long history of earnings increases and dividend increases is obviously stable and there's a reasonable chance it will continue to perform well in the industry."

"McDonald's (MCD, Financial) earnings have gone up, I think, more than 80 fold over the past 30 years, the stock is up 100 fold. What made McDonald's earnings continue to grow? If they just stuck with the cheap cheeseburger and the cheap hamburger at lunch, they probably would've run into earnings problems 10 or 15 years ago, but they expanded their menu, they kept the costs low, they had a breakfast and went overseas. Every day they added two or three more restaurants, people thought there was no room for more McDonald's five, 10, 15 years ago. They were wrong. If they had done the research, they would have seen there are a couple hundred countries out there for the company to expand into."

"Remember, the beauty of growth companies is that you have plenty of time the buy. If they are going to grow for five, 10 or 30 years, you don't have to be there the first year or second year. You could've bought Wal-Mart (WMT, Financial) 10 years after they went public and made 30 times your money."

"One way you can look at growth companies is to think of baseball. A baseball game has nine innings, you should look at the growth company and say 'I don't want to buy it when they're in the first inning.I want to buy when they're in the second or third inning because they have the formula right. They have room to grow.' You want to say to yourself that this is a company that is very early in its cycle."

“You have to understand that stock picking is a risk-reward tradeoff. You have to understand how much you're going to make if you’re right and how much you’re going to lose if you’re wrong. The skill is to minimize your risk, and maximize your reward. You can be wrong in this business. I have been wrong quite a bit. But you can be wrong and still make money as long as your good stocks more than offset your mistakes. I figure if I can be right six times out of 10, then that’s a good batting average."

“When I feel that my story is solid and well-researched, then I have a low-risk investment. If I’m not too sure about how the story will work out, then the risk is considerably higher. Don’t try and measure risk using other measures like 'small companies are riskier than large.'”

Disclosure: The author owns no stocks mentioned.