by John Reese, editor Validea
Choosing the greatest fund manager of all-time is a tough task. But, if
you were to rank Peter Lynch at the top of the list, you'd probably find
few would disagree with you.
If you'd invested $10,000 in
Fidelity Magellan the day Lynch took the helm, you would have had
$280,000 on the day he retired 13 years later.
Just what was it about Lynch's approach that made him so incredibly
successful? Interestingly, a big part of his approach involved something
that is not at all exclusive to being a renowned professional fund
He invested in what he knew. Lynch believed that if you
personally know something positive about a stock -- you buy the
company's products, like its marketing, etc. -- you can get a beat on
successful businesses before professional investors get around to them.
most important fundamental he looked at was one whose use he pioneered:
the "PEG" ratio, divides a stock's p/e by its historical growth rate.
The theory behind this was relatively simple: The faster a company was
growing, the more you should be willing to pay for its stock.
Lynch, PEGs below 1.0 were signs of growth stocks selling on the cheap;
PEGs below 0.5 really indicated that a growth stock was a bargain.
addition to "fast-growers" Lynch looked for "stalwarts" and
"slow-growers", which tend to offer strong dividend yields; as such,
Lynch adjusted their PEG calculations to include yield. He also looked
at the inventory/sales ratio and the debt/equity ratio.
The final part of the Lynch strategy includes two bonus categories: free
cash flow/price ratio and net cash/price ratio. Lynch loved it when a
stock had a free cash flow/price ratio greater than 35 percent, or a net
cash/price ratio over 30 percent.
For most of the time since I
started tracking it in July 2003, my Lynch-based 10-stock portfolio has
been one of my better performers. It has averaged annualized returns of
5.3%, easily beating the 3.1% annualized return for the S&P 500.
portfolio's performance numbers have been hurt by a poor 2011 and a
sub-par first part of 2012 (down 1.5%), but given its long-term track
record, I expect the recent troubles are short-term and wouldn't be
surprised to see the portfolio post some strong bounce-back gains before
the year is over.
Here's a look at the stocks that currently make up my 10-stock Lynch-based portfolio:Ternium S.A.
)Kulicke and Soffa Industries
)GT Advanced Technologies
it's not a quantitative factor, there is another part of Lynch's
strategy that was a critical part of his success, and it's one that is
particularly relevant given the portfolio's rough recent run: Don't bail
when things get bad.
Lynch recognized that the stock market was
unpredictable in the short term, even to the smartest investors. His
philosophy: Use a proven strategy and stay in the market for the long
term and you'll realize those gains; jump in and out and there's a good
chance that you'll miss out on a chunk of them.
That, of course,
is particularly hard to do when the market gets volatile. But Lynch said
it's critical to stay disciplined: "The real key to making money in
stocks," he once said, "is not to get scared out of them."