When amateurs beat analysts

BOOK REVIEW

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"You can't probably gain an edge as an investor from Wall Street experts. It's something you already have. You can outperform the experts if you use your inherent edge by investing in companies or industries you understand," he writes.

In fact, Lynch owes much of his popularity among investors to his invest-in-what-you-know strategy. The strategy also partly explains the success of Fidelity Magellan Fund, the top-ranked general equity fund in the US, during the period between 1977 and 1990 when Lynch was its manager ($1,000 invested in Magellan when Lynch joined the fund were worth $28,000 when he left it).

In Beating the Street Lynch elaborates two of his pet themes - how to pick winning stocks and develop a strategy for mutual funds - for amateur investors.

Lynch is a perennial advocate of equities. "A portfolio of stocks or stock mutual funds will always turn out to be more valuable than one of bonds money-market funds." But a penchant for stocks alone wouldn't be enough.

"Investing in stocks is fun. But it could be dangerous if you don't do enough homework." An important key to investing, Lynch says, is to remember that stocks are not lottery tickets. There's a company behind every stock. So one needs to understand what the company he or she has invested in is doing.

This doesn't necessarily mean listening to all the noise from the Street. Of late, the stock market has come to be dominated by a herd of professional investors. Contrary to popular belief, this makes it easier for the amateur investor.

"You can beat the market by ignoring the herd," asserts Lynch. "An amateur who studies companies in an industry he or she knows can outperform 95 per cent of the paid experts who manage the mutual funds, plus have fun in doing it," he affirms.

To substantiate his argument, he describes how a bunch of seventh graders at St Agnes School in a Boston suburb have produced a two-year investment record that Street professionals can only envy.

A larger bunch of adult amateurs belonging to investment clubs sponsored by the Michigan-based National Association of Investors Corp (NAIC) have also bested their professional counterparts for many years in a row.

Both bunches of amateurs have this in common: they invested on a regular timetable, which took the guesswork out of whether the market was headed up or down.

Amateurs are often wary about declines. But they are not as dreadful as they are made out to be. "A decline is an opportunity to pick up the bargains left behind by investors who panic," counsels Lynch. Panic grips when you do something without trusting it. "The stock market isn't not a gamble, as long as you pick good companies that you think will do well".

However, belief in yourself shouldn't prompt you to gulp more than what you can. "Hold no more stocks than you can remain informed on." Surplus affection for any particular scrip could be as pernicious an extra dose of self-trust.

"Never fall in love with a stock. Keep your mind open." Restraint will also help you say 'stop' when you ought to. "Just because a stock goes down doesn't mean it can't go lower".

Lynch recommends a few time-tested checks that would guard you from pitfalls. For instance, examine, first, if sales and earnings per share of the company are moving forward at an acceptable rate and, second, whether you can buy the stock at a reasonable price.

It is also well to consider the financial strength and debt structure to see if a few bad years would hinder the company's long-term progress.

Whatever method you use to pick stocks or stock mutual funds, your success or failure will depend on your ability to ignore the worries of the world long enough to allow your investments to succeed. The skittish investor is susceptible to getting flushed out of the market by the brush beaters of doom.

Who will own pharma shares if the AIDS virus is going to kill half the consumers and the hole in the ozone the other half? "Sell a stock because the company's fundamentals deteriorate, not because the sky is falling," Lynch pronounces.

As for mutual funds, the person who blithely ignores the condition of the market and invests on a regular schedule is better off than the person who studies a lot about market behaviour and tries to time his investments.

The easiest approach is to divide your money into four or six types of stock funds (growth, value, emerging growth, etc.). So you will have some money invested in the most profitable sector of the market. Lynch prefers stock funds to bond or money-market funds.

"Put as much money into stock funds as you can. Even if you need income, you will be better off in the long run to own dividend-paying stocks and to occasionally dip into capital as an income substitute."

But If you must own government bonds, "buy them outright from the treasury and avoid bond funds where you pay management fees for nothing".

Whether it is stocks or stock funds, rely on your own experience and insights. There is no reason why the individual investor can't match wits with experts especially when analysts blabber about something they themselves are not sure about.

"Nobody can predict interest rates, the future direction of the economy or the stock market. Dismiss all such forecasts and concentrate on what's happening to the company in which you have invested."

Lynch extends a generous helping of maxims but is averse to offering pat formulas. After all, there are no bells that ring when you buy the right stock, and no matter how much you know about a company you can never be certain that it will reward you for investing in it.

But if you know the factors that make the company profitable or unprofitable, you can improve your odds. Many of these factors are laid out in this book. So, go ahead and pick it.

Beating the Street

Author: Peter Lynch with John Rothchild
Publisher: Simon & Schuster
Edition: 1994, paperback
Price: Rs 555
Book courtesy: Crossword