Systemic Value Investing

The speaker summarizes the principles of Peter Lynch, Warren Buffett and Benjamin Graham.
@25 min:  Long term investing - holding on to your strategies for the long term.

Great Investors Not Named Buffett

George SorosPerhaps it would have seemed impossible to imagine as he was living through World War II, but George Soros became one of the most successful investors in history. With a current net worth north of $14 billion, Soros is largely retired as an active investor. However, he established a remarkable record while running the Quantum Group of hedge funds. 

Soros is mostly known for his successes in making large bets in the currency and commodity markets. The most famous success story of his career is most likely Britain's Black Wednesdaycurrency crisis, where Soros correctly surmised that the country would have to devalue the pound and reportedly made around $1 billion on his positions. 

Whereas Buffett is famous for carefully evaluating individual companies and holding those positions for years, Soros was much more inclined to base his investment decisions on what would be considered macroeconomic factors. What's more, investments in the currency and commodity markets do not lend themselves to multi-decade (or even multi-month) commitments, so Soros was a much more active investor. (George Soros spent decades as one of the world's elite investors, and even he didn't always come out on top. But when he did, it was spectacular. Check out George Soros: The Philosophy Of An Elite Investor.) 

Ronald PerelmanSome will question whether Perelman is properly called an "investor." Though no one will dispute that a net worth of approximately $12 billion entitles him to be seen as a significant success in business, Pererlman's activities have centered on acquiring businesses outright, refocusing them on core competencies (often through spin-offs) and then either selling the companies later at a profit or holding onto them for the cashflow they produce. In that latter regard, though, Perelman is not so unlike Buffett - much of Buffett's success can be tied to the prudent acquisition of value-creating businesses within Berkshire Hathaway. 

While Perelman has frequently faced criticism for his acquisition tactics and management decisions, he has nevertheless had many successful transactions, including his involvement in Marvel, New World Communications and several thrifts, savings and loans and banks. 

Try Currency Trading Risk-Free at FOREX.com  

John PaulsonWith about $16 billion in net worth, John Paulson is arguably the most successful hedge fund investor today. What makes that even more impressive is that he founded Paulson & Co in 1994 with purportedly with only $2 million. Paulson really made his name during the credit crisis that marked the end of the housing bubble; reportedly shorting CDOs, mortgage backed securities and other tainted housing-related assets, as well as shorting the shares of several major British banks. Perhaps ironically, Paulson has benefited from both sides of that trade, having also taken long positions in companies like Regions Financial, Goldman Sachs, Bank of America and Citigroup. 

Carl IcahnIn some respects, Carl Icahn follows an approach that is somewhat similar to Warren Buffett, as Icahn has built his fortune through a combination of equity investments and outright acquisitions. That is where the similarities end, though, as Icahn has generally pursued a much more aggressive strategy and shown no particular reticence to launch hostile offers. What's more, Icahn is not often interested in investing in business and seeing them continue to run as before; Icahn has built a reputation as a so-called activist investor who frequently pushes corporate managements to restructure, sell assets and return cash to shareholders. 

Differences aside, Icahn's strategy has worked. Icahn has built a fortune reportedly worth in excess of $11 billion through his involvement in a range of companies including RJR Nabisco, Viacom and Time Warner. (Buying up failing investments and turning them around helped to create the "Icahn lift" phenomenon. To learn more, check out Carl Icahn's Investing Strategy.)

James SimonsIf there is an "anti-Buffett" on this list, James Simons may be a good candidate. Holding a PhD in mathematics from Berkeley, Simons founded Renaissance Technologies and uses exceptionally complicated mathematical models to analyze and evaluate trading opportunities. While Buffett is famous for having a minimal staff, Renaissance Technologies reportedly employs dozens of PhDs in fields like physics, mathematics and statistics to find previously under-used correlations and connections that can be used for better trading results. 

Or at least that is as much as is known about Renaissance Technologies - while Buffett is rather open about his investment philosophies and methodologies, Simons maintains a much lower profile. Nevertheless, this heavily quantitative approach seems to work. Mr. Simons is estimated to be worth nearly $11 billion and his funds have been so successful that they can charge outsized management fees and profit participation percentages to investors. 

Others Worthy Of NoteInvestors would also do well to consider the careers of other well-known investors like Jim Rogers, Mark Mobius, and Peter Lynch. While Mobius is the only one of the three still highly involved in day-to-day investment operators, all three men have become very closely associated with their particular investment philosophies. Rogers is a go-to commentator on commodities and macroeconomic investments, while Mobius may be the best known emerging-markets investor of all time. 

Peter Lynch, though many years removed his tenure at Fidelity and his management of the Magellan fund, is still widely seen as a leading voice in "disciplined growth" investing. All three men have written about their investment philosophies and outlooks, and their approaches are accessible and informative. (For related reading, check Pick Stocks Like Peter Lynch.)

The Bottom LineInvestors should cast their eyes beyond Warren Buffett if they wish to really learn about all that investing can offer. There is no doubting or ignoring Buffett's exemplary record, but there is always more to learn by broadening the pool of examples. While investors like Simons and Soros may seem to focus on strategies and techniques that are beyond the means of regular investors, there are still valuable lessons to be learned about macroeconomics and the benefits of looking at the markets in new and proprietary ways. 

http://www.investopedia.com/financial-edge/0511/great-investors-not-named-buffett.aspx?utm_source=coattail-buffett&utm_medium=Email&utm_campaign=WBW-7/18/2013

5 Investing Styles dominate today. Value Investing is fashionable again.

FIVE investing styles dominate today:

1.  Value Investors
They rely on fundamental analysis of companies' financial performance to identify stocks priced below intrinsic value (the present value of a company's future cash flows.)
Benjamin Graham and David Dodd in the 1930s.
Warren Buffett in the 1970s and 1980s.

2.  Growth Investors
They seek companies whose earnings gains promise to boost intrinsic value rapidly.
Philip Fisher late 1950s.
Peter Lynch in the 1980s.

3.  Index Investors
They buy shares that replicate a large market segment such as the S&P 500.
Endorsed by Graham for defensive investors.
John Bogle in the 1980s.

4.  Technical Investors
They use charts to glean market behaviour indiccating whether expectations are rising or falling, market trends, and other "momentum" indicators.
William O'Neill in the late 1990s.

5.  Portfolio Investors
Tney ascertain their appetite for investment risk and assemble a diversified securities protfolio bearing the risk level.
Burton G. Malkiel in early 1970s.

Sir John Templeton and Peter Lynch

Peter Lynch's 25 Golden Rules of Investment

Peter Lynch Fidelity Investments

The Peter Lynch Approach in Brief

•The Peter Lynch Approach in Brief

•Philosophy and style

•Investment in companies in which there is a well-grounded expectation concerning the firm’s growth prospects and in which the stock can be bought at a reasonable price.

•A thorough understanding of the company and its competitive environment is the only "edge" investors have over other investors in finding reasonably valued stocks.

•Universe of stocks

•All listed and over-the-counter stocks - no restrictions.

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•Criteria for initial consideration

•Select from industries and companies with which you are familiar and have an understanding of the factors that will move the stock price.

•Make sure you can articulate a prospective stock’s "story line"-the company’s plans for increasing growth and any other series of events that will help the firm-and make sure you understand and balance them against any potential pitfalls.

•Categorizing the stocks among six major "story" lines is helpful when evaluating prospective stocks.

•Criteria for initial consideration

•Specific factors depend on the firm’s "story," but these factors should be examined:

1.Year-by-year earnings: Look for stability and consistency, and an upward trend.

2.P/E relative to historical average: The price-earnings ratio should be in the lower range of its historical average.

3.P/E relative to industry average: The price-earnings ratio should be below the industry average.

4.P/E relative to earnings growth rate: A price-earnings ratio of half the level of historical earnings growth is attractive; relative ratios above 2.0 are unattractive. For dividend-paying stocks, use the price-earnings ratio divided by the sum of the earnings growth rate and dividend yield-ratios below 0.5 are attractive, ratios above 1.0 are poor.

5.Debt-equity ratio: The company’s balance sheet should be strong, with low levels of debt relative to equity financing, and be particularly wary of high levels of bank debt.

6.Net cash per share: The net cash per share relative to share price should be high.

7.Dividends and payout ratio: For investors seeking dividend-paying firms, look for a low payout ratio (earnings per share divided by dividends per share) and long records (20 to 30 years) of regularly raising dividends.

8.Inventories: Particularly important for cyclicals, inventories that are piling up are a warning flag, particularly if growing faster than sales.

•Other favorable characteristics

•The name is boring, the product or service is in a boring area, the company does something disagreeable or depressing, or there are rumors of something bad about the company.

•The company is a spin-off.

•The fast-growing company is in a no-growth industry.

•The company is a niche firm controlling a market segment.

•The company produces a product that people tend to keep buying during good times and bad.

•The company can take advantages of technological advances, but is not a direct producer of technology.

•The is a low percentage of shares held by institutions and there is low analyst coverage.

•Insiders are buying shares.

•The company is buying back shares.

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•Unfavorable characteristics

•Hot stocks in hot industries.

•Companies (particularly small firms) with big plans that have not yet been proven.

•Profitable companies engaged in diversifying acquisitions. Lynch terms these "diworseifications."

•Companies in which one customer accounts for 25% to 50% of their sales.

•Stock monitoring and when to sell

•Do not diversify simply to diversify, particularly if it means less familiarity with the firms. Invest in whatever number of firms is large enough to still allow you to fully research and understand each firm. Invest in several categories of stock for diversification.

•Review holdings every few months, rechecking the company "story" to see if anything has changed. Sell if the "story" has played out as expected or something in the story fails to unfold as expected or fundamentals deteriorate.

•Price drops usually should be viewed as an opportunity to buy more of a good prospect at cheaper prices.

•Consider "rotation"-selling played-out stocks with stocks with a similar story, but better prospects. Maintain a long-term commitment to the stock market and focus on relative fundamental values.

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The Peter Lynch Approach to Investing in "Understandable" Stocks

•The Peter Lynch Approach to Investing in "Understandable" Stocks

•No modern-day investment "sage" is better known than Peter Lynch.

•Not only has his investment approach successfully passed the real-world performance test, but he strongly believes that individual investors have a distinct advantage over Wall Street and large money managers when using his approach.

•The Peter Lynch Approach to Investing in "Understandable" Stocks

•Individual investors, he feels, have more flexibility in following this basic approach because they are unencumbered by bureaucratic rules and short-term performance concerns.

•The Peter Lynch Approach to Investing in "Understandable" Stocks

•Mr. Lynch developed his investment philosophy at Fidelity Management and Research, and gained his considerable fame managing Fidelity’s Magellan Fund.

•The fund was among the highest-ranking stock funds throughout Mr. Lynch’s tenure, which began in 1977 at the fund’s launching, and ended in 1990, when Mr. Lynch retired.

•The Peter Lynch Approach to Investing in "Understandable" Stocks

•Peter Lynch’s approach is strictly bottom-up, with selection from among companies with which the investor is familiar, and then through fundamental analysis that emphasizes a thorough understanding of the company, its prospects, its competitive environment, and whether the stock can be purchased at a reasonable price.

•The Peter Lynch Approach to Investing in "Understandable" Stocks

•His basic strategy is detailed in his best-selling book "One Up on Wall Street" [Penguin Books paperback, 1989], which provides individual investors with numerous guidelines for adapting and implementing his approach.

•His most recent book, "Beating the Street" [Fireside/Simon & Schuster paperback, 1994], amplifies the theme of his first book, providing examples of his approach to specific companies and industries in which he has invested.

•These are the primary sources for this article.

•The Philosophy: Invest in What You Know

•Lynch is a "story" investor.

•That is, each stock selection is based on a well-grounded expectation concerning the firm’s growth prospects.

•The expectations are derived from the company’s "story"--what it is that the company is going to do, or what it is that is going to happen, to bring about the desired results.

•The Philosophy: Invest in What You Know

•The more familiar you are with a company, and the better you understand its business and competitive environment, the better your chances of finding a good "story" that will actually come true.

•The Philosophy: Invest in What You Know

•For this reason, Lynch is a strong advocate of investing in companies with which one is familiar, or whose products or services are relatively easy to understand.

•Thus, Lynch says he would rather invest in "pantyhose rather than communications satellites," and "motel chains rather than fiber optics.”

•The Philosophy: Invest in What You Know

•Lynch does not believe in restricting investments to any one type of stock.

• His "story" approach, in fact, suggests the opposite, with investments in firms with various reasons for favorable expectations.

•The Philosophy: Invest in What You Know

•In general, however, he tends to favor small, moderately fast-growing companies that can be bought at a reasonable price.

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•Selection Process

•Lynch’s bottom-up approach means that prospective stocks must be picked one-by-one and then thoroughly investigated--there is no formula or screen that will produce a list of prospective "good stories.”

•Selection Process

•Instead, Lynch suggests that investors keep alert for possibilities based on their own experiences--for instance, within their own business or trade, or as consumers of products.

•Selection Process

•The next step is to familiarize yourself thoroughly with the company so that you can form reasonable expectations concerning the future.

•Selection Process

•However, Lynch does not believe that investors can predict actual growth rates, and he is skeptical of analysts’ earnings estimates.

•Selection Process

•Instead, he suggests that you examine the company’s plans--how does it intend to increase its earnings, and how are those intentions actually being fulfilled?

•Selection Process

•Lynch points out five ways in which a company can increase earnings:

1.It can reduce costs;

2.raise prices;

3.expand into new markets;

4.sell more in old markets; or

5.revitalize, close, or sell a losing operation.

•Selection Process

•The company’s plan to increase earnings and its ability to fulfill that plan are its "story," and the more familiar you are with the firm or industry, the better edge you have in evaluating the company’s plan, abilities, and any potential pitfalls.

•Selection Process

•Categorizing a company, according to Lynch, can help you develop the "story" line, and thus come up with reasonable expectations.

1. He suggests first categorizing a company by size. Large companies cannot be expected to grow as quickly as smaller companies.

2.Next, he suggests categorizing a company by "story" type, and he identifies six.

•Selection Process

•Next, he suggests categorizing a company by "story" type, and he identifies six:

1.Slow Growers

2.Stalwarts

3.Fast-Growers

4.Cyclicals

5.Turnarounds

6.Asset opportunities

•Slow Growers

•Slow Growers: Large and aging companies expected to grow only slightly faster than the U.S. economy as a whole, but often paying large regular dividends.

•These are not among his favorites.

•Stalwarts

•Stalwarts: Large companies that are still able to grow, with annual earnings growth rates of around 10% to 12%; examples include Coca-Cola, Procter & Gamble, and Bristol-Myers.

•If purchased at a good price, Lynch says he expects good but not enormous returns--certainly no more than 50% in two years and possibly less.

•Lynch suggests rotating among the companies, selling when moderate gains are reached, and repeating the process with others that haven’t yet appreciated.

•These firms also offer downside protection during recessions.

•Fast-Growers

•Fast-Growers: Small, aggressive new firms with annual earnings growth of 20% to 25% a year.

•These do not have to be in fast-growing industries, and in fact Lynch prefers those that are not.

•Fast-growers are among Lynch’s favorites, and he says that an investor’s biggest gains will come from this type of stock.

•However, they also carry considerable risk.

•Cyclicals

•Cyclicals: Companies in which sales and profits tend to rise and fall in somewhat predictable patterns based on the economic cycle; examples include companies in the auto industry, airlines and steel.

•Lynch warns that these firms can be mistaken for stalwarts by inexperienced investors, but share prices of cyclicals can drop dramatically during hard times.

•Thus, timing is crucial when investing in these firms, and Lynch says that investors must learn to detect the early signs that business is starting to turn down.

•Turnarounds

•Turnarounds: Companies that have been battered down or depressed--Lynch calls these "no-growers"; his examples include Chrysler, Penn Central and General Public Utilities (owner of Three Mile Island).

•The stocks of successful turnarounds can move back up quickly, and Lynch points out that of all the categories, these upturns are least related to the general market.

•Asset opportunities

•Asset opportunities: Companies that have assets that Wall Street analysts and others have overlooked.

•Lynch points to several general areas where asset plays can often be found--metals and oil, newspapers and TV stations, and patented drugs.

•However, finding these hidden assets requires a real working knowledge of the company that owns the assets, and Lynch points out that within this category, the "local" edge--your own knowledge and experience--can be used to greatest advantage.

•Selection Criteria

•Analysis is central to Lynch’s approach.

•In examining a company, he is seeking to understand the firm’s business and prospects, including any competitive advantages, and evaluate any potential pitfalls that may prevent the favorable "story" from occurring.

•Selection Criteria

•In addition, an investor cannot make a profit if the story has a happy ending but the stock was purchased at a too-high price.

•For that reason, he also seeks to determine reasonable value.

•Some Key Numbers Lynch suggests Investors examine

•Here are some of the key numbers Lynch suggests investors examine:

1.Year-by-year earnings

2.Earnings growth

3.The price-earnings ratio

4.The price-earnings ratio relative to its historical average

5.The price-earnings ratio relative to the industry average

6.The price-earnings ratio relative to its earnings growth rate

7.Ratio of debt to equity

8.Net cash per share

9.Dividends & payout ratio

10.Inventories

•Some Key Numbers Lynch suggests Investors examine

•Year-by-year earnings: The historical record of earnings should be examined for stability and consistency.

•Stock prices cannot deviate long from the level of earnings, so the pattern of earnings growth will help reveal the stability and strength of the company.

•Ideally, earnings should move up consistently.

•Some Key Numbers Lynch suggests Investors examine

•Earnings growth: The growth rate of earnings should fit with the firm’s "story"--fast-growers should have higher growth rates than slow-growers.

•Extremely high levels of earnings growth rates are not sustainable, but continued high growth may be factored into the price.

•A high level of growth for a company and industry will attract a great deal of attention from both investors, who bid up the stock, and competitors, who provide a more difficult business environment.

•Some Key Numbers Lynch suggests Investors examine

•The price-earnings ratio: The earnings potential of a company is a primary determinant of company value, but at times the market may get ahead of itself and overprice a stock.

•The price-earnings ratio helps you keep your perspective, by comparing the current price to most recently reported earnings.

•Stocks with good prospects should sell with higher price-earnings ratios than stocks with poor prospects.

•Some Key Numbers Lynch suggests Investors examine

•The price-earnings ratio relative to its historical average: Studying the pattern of price-earnings ratios over a period of several years should reveal a level that is "normal" for the company.

•This should help you avoid buying into a stock if the price gets ahead of the earnings, or sends an early warning that it may be time to take some profits in a stock you own.

•Some Key Numbers Lynch suggests Investors examine

•The price-earnings ratio relative to the industry average: Comparing a company’s price-earnings ratio to the industry’s may help reveal if the company is a bargain.

•At a minimum, it leads to questions as to why the company is priced differently--is it a poor performer in the industry, or is it just neglected?

•Some Key Numbers Lynch suggests Investors examine

•The price-earnings ratio relative to its earnings growth rate: Companies with better prospects should sell with higher price-earnings ratios, but the ratio between the two can reveal bargains or overvaluations.

•A price-earnings ratio of half the level of historical earnings growth is considered attractive, while relative ratios above 2.0 are unattractive.

•For dividend-paying stocks, Lynch refines this measure by adding the dividend yield to the earnings growth [in other words, the price-earnings ratio divided by the sum of the earnings growth rate and dividend yield].  With this modified technique, ratios above 1.0 are considered poor, while ratios below 0.5 are considered attractive.

•Some Key Numbers Lynch suggests Investors examine

•Ratio of debt to equity : How much debt is on the balance sheet? A strong balance sheet provides maneuvering room as the company expands or experiences trouble.

•Lynch is especially wary of bank debt, which can usually be called in by the bank on demand.

•Some Key Numbers Lynch suggests Investors examine

•Net cash per share: Net cash per share is calculated by adding the level of cash and cash equivalents, subtracting long-term debt, and dividing the result by the number of shares outstanding.

•High levels provide a support for the stock price and indicate financial strength.

•Some Key Numbers Lynch suggests Investors examine

•Dividends & payout ratio: Dividends are usually paid by the larger companies, and Lynch tends to prefer smaller growth firms.

•However, Lynch suggests that investors who prefer dividend-paying firms should seek firms with the ability to pay during recessions (indicated by a low percentage of earnings paid out as dividends), and companies that have a 20-year or 30-year record of regularly raising dividends.

•Some Key Numbers Lynch suggests Investors examine

•Inventories: Are inventories piling up? This is a particularly important figure for cyclicals.

•Lynch notes that, for manufacturers or retailers, an inventory buildup is a bad sign, and a red flag is waving when inventories grow faster than sales.

•On the other hand, if a company is depressed, the first evidence of a turnaround is when inventories start to be depleted.

•When evaluating companies, there are certain characteristics that Lynch finds particularly favorable.

•When evaluating companies, there are certain characteristics that Lynch finds particularly favorable. These include:

•The name is boring, the product or service is in a boring area, the company does something disagreeable or depressing, or there are rumors of something bad about the company--Lynch likes these kinds of firms because their ugly duckling nature tends to be reflected in the share price, so good bargains often turn up. Examples he mentions include: Service Corporation International (a funeral home operator--depressing); and Waste Management (a toxic waste clean-up firm--disagreeable).

•The company is a spin-off--Lynch says these often receive little attention from Wall Street, and he suggests that investors check them out several months later to see if insiders are buying.

•The fast-growing company is in a no-growth industry--Growth industries attract too much interest from investors (leading to high prices) and competitors.

•The company is a niche firm controlling a market segment or that would be difficult for a competitor to enter.

•The company produces a product that people tend to keep buying during good times and bad--such as drugs, soft drinks, and razor blades--More stable than companies whose product sales are less certain.

•The company is a user of technology--These companies can take advantage of technological advances, but don’t tend to have the high valuations of firms directly producing technology, such as computer firms.

•There is a low percentage of shares held by institutions, and there is low analyst coverage--Bargains can be found among firms neglected by Wall Street.

•Insiders are buying shares--A positive sign that insiders feel particularly confident about the firm’s prospects.

•The company is buying back shares--Buybacks become an issue once companies start to mature and have cash flow that exceeds their capital needs. Lynch prefers companies that buy their shares back over firms that choose to expand into unrelated businesses. The buyback will help to support the stock price and is usually performed when management feels share price is favorable.

•When evaluating companies, there are certain characteristics that Lynch finds particularly favorable.

•The name is boring, the product or service is in a boring area, the company does something disagreeable or depressing, or there are rumors of something bad about the company--Lynch likes these kinds of firms because their ugly duckling nature tends to be reflected in the share price, so good bargains often turn up.

•Examples he mentions include: Service Corporation International (a funeral home operator--depressing); and Waste Management (a toxic waste clean-up firm--disagreeable).

•When evaluating companies, there are certain characteristics that Lynch finds particularly favorable.

•The company is a spin-off--Lynch says these often receive little attention from Wall Street, and he suggests that investors check them out several months later to see if insiders are buying.

•When evaluating companies, there are certain characteristics that Lynch finds particularly favorable.

•The fast-growing company is in a no-growth industry--Growth industries attract too much interest from investors (leading to high prices) and competitors.

•When evaluating companies, there are certain characteristics that Lynch finds particularly favorable.

•The company is a niche firm controlling a market segment or that would be difficult for a competitor to enter.

•When evaluating companies, there are certain characteristics that Lynch finds particularly favorable.

•The company produces a product that people tend to keep buying during good times and bad--such as drugs, soft drinks, and razor blades--more stable than companies whose product sales are less certain.

•When evaluating companies, there are certain characteristics that Lynch finds particularly favorable.

•The company is a user of technology--These companies can take advantage of technological advances, but don’t tend to have the high valuations of firms directly producing technology, such as computer firms.

•When evaluating companies, there are certain characteristics that Lynch finds particularly favorable.

•There is a low percentage of shares held by institutions, and there is low analyst coverage.

•Bargains can be found among firms neglected by Wall Street.

•When evaluating companies, there are certain characteristics that Lynch finds particularly favorable.

•Insiders are buying shares.

•A positive sign that insiders feel particularly confident about the firm’s prospects.

•When evaluating companies, there are certain characteristics that Lynch finds particularly favorable.

•The company is buying back shares.

•Buybacks become an issue once companies start to mature and have cash flow that exceeds their capital needs.

•Lynch prefers companies that buy their shares back over firms that choose to expand into unrelated businesses.

•The buyback will help to support the stock price and is usually performed when management feels share price is favorable.

•Selection Criteria

•Characteristics Lynch finds unfavorable are:

1.Hot stocks in hot industries.

2.Companies (particularly small firms) with big plans that have not yet been proven.

3.Profitable companies engaged in diversifying acquisitions. Lynch terms these "diworseifications."

4.Companies in which one customer accounts for 25% to 50% of their sales.

•Portfolio Building and Monitoring

•As portfolio manager of Magellan, Lynch held as many as 1,400 stocks at one time.

•Although he was successful in juggling this many stocks, he does point to significant problems of managing such a large number of stocks.

•Portfolio Building and Monitoring

•Individual investors, of course, will get nowhere near that number, but he is wary of over-diversification just the same.

•There is no point in diversifying just for the sake of diversifying, he argues, particularly if it means less familiarity with the firms.

•Portfolio Building and Monitoring

•Lynch says investors should own however many "exciting prospects" that they are able to uncover that pass all the tests of research.

•Portfolio Building and Monitoring

•Lynch also suggests investing in several categories of stocks as a way of spreading the downside risk.

•On the other hand, Lynch warns against investment in a single stock.

•Portfolio Building and Monitoring

•Lynch is an advocate of maintaining a long-term commitment to the stock market.

•He does not favor market timing, and indeed feels that it is impossible to do so.

•Portfolio Building and Monitoring

•But that doesn’t necessarily mean investors should hold onto a single stock forever.

•Instead, Lynch says investors should review their holdings every few months, rechecking the company "story" to see if anything has changed either with the unfolding of the story or with the share price.

•Portfolio Building and Monitoring

•The key to knowing when to sell, he says, is knowing "why you bought it in the first place.”

•Portfolio Building and Monitoring

•Lynch says investors should sell if:

1.The story has played out as expected and this is reflected in the price; for instance, the price of a stalwart has gone up as much as could be expected.

2.Something in the story fails to unfold as expected or the story changes, or fundamentals deteriorate; for instance, a cyclical’s inventories start to build, or a smaller firm enters a new growth stage.

•Portfolio Building and Monitoring

•For Lynch, a price drop is an opportunity to buy more of a good prospect at cheaper prices..

•Portfolio Building and Monitoring

•It is much harder, he says, to stick with a winning stock once the price goes up, particularly with fast-growers where the tendency is to sell too soon rather than too late.

•With these firms, he suggests holding on until it is clear the firm is entering a different growth stage.

•Portfolio Building and Monitoring

•Rather than simply selling a stock, Lynch suggests "rotation“ -- selling the company and replacing it with another company with a similar story, but better prospects.

•The rotation approach maintains the investor’s long-term commitment to the stock market, and keeps the focus on fundamental value.

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•Summing It Up

•Lynch offers a practical approach that can be adapted by many different types of investors, from those emphasizing fast growth to those who prefer more stable, dividend-producing investments.

•His strategy involves considerable hands-on research, but his books provide lots of practical advice on what to look for in an individual firm, and how to view the market as a whole.

•Summing It Up

•Lynch sums up stock investing and his outlook best:

"Frequent follies notwithstanding, I continue to be optimistic about America, Americans, and investing in general. When you invest in stocks, you have to have a basic faith in human nature, in capitalism, in the country at large, and in future prosperity in general. So far, nothing’s been strong enough to shake me out of it."

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•http://www.csulb.edu/~pammerma/fin382/screener/lynch.htm

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•AAII Journal - January 1997

•By Maria Crawford Scott

•Maria Crawford Scott is editor of the AAII Journal.