This is part six of a ten-part series on our Small-Cap Investing Guide.
Throughout this series, I’m looking at both the benefits, and drawbacks of investing in small caps, considering all of the evidence available to us today for both sides of the debate.
When completed we are planning to turn the series into an e-book, which we hope will be a comprehensive guide to investing in small caps.
For the other parts of this Small-Cap Investing Guide series please follow the links below:
- Part One: Introduction
- Part Two: The Small-Cap Premium
- Part Three: Size Matters
- Quality Over Quantity
- Peter Lynch’s Rules
So far in this series, I’ve looked at the academic research on small-cap investing but while academic research is always interesting, it’s no substitute for real-world experience. With that being the case, in parts five and six of this series are devoted to Peter Lynch.
Small-Cap Investing Guide Part Six: Peter’s Principles
Why spend so much time on Lynch and his principles? Well, when it comes to real world experience you just can’t beat the experience and record of Lynch.
There have been plenty of other successful small-cap investors throughout history but Lynch is the only investor to be able to have successfully replicated his stock picking success with thousands of equities.
So, here are Peter Lynch’s 21 “Peter’s Principles”, which are intended to sum up the points made in his book, Beating the Street.
Small-Cap Investing Handbook – Peter Lynch’s Principles
When the operas outnumber the football games three to zero, you know there is something wrong with your life.
This point relates specifically to Lynch’s desire to spend more time with his family rather than trying to keep up with all his equities, but the idea behind the principle is simply to remember to make time for what you love in life.
Gentlemen who prefer bonds don’t know what they are missing.
Bonds are inferior to stocks.
Never invest in any idea you can’t illustrate with a crayon.
Buffett has a similar process whereby he avoids what he does not understand. This is the same principle.
You can’t see the future through a rearview mirror.
Past returns are not a guide to future success.
There’s no point paying Yo-Yo Ma to play a radio.
There’s no point paying a bond manager when you can just go and buy the bonds yourself for no annual management fee. The same principle can be used with high costs active funds that closet index.
As long as you’re picking a fund, you might as well pick a good one.
It pays to do your research.
The extravagance of any corporate office is directly proportional to management’s reluctance to reward shareholders.
Excellent companies are thrifty.
When yields on long-term government bonds exceed the dividend yield of the S&P 500 by 6 percent or more, sell your stocks and buy bonds.
This goes against principle two, but it’s offered as a sort of defensive strategy.
Not all common stocks are equally common.
Some companies are very special. Others are junk.
Never look back when you’re driving on the autobahn.
The best stock to buy may be the one you already own.
A sure cure for taking a stock for granted is a big drop in the price.
Nothing brings you back down to earth after a string of winning positions more than a sudden loss.
Never bet on a comeback while they’re playing “Taps”.
(“Taps” is the name of that bugle tune they play at military funerals. In stock terms, it never pays to buy a stock just because its share price has fallen.)
If you like the store, chances are you’ll love the stock.
Successful companies can be spotted before their stock market darlings by watching how many people use the store. Footfall will reveal more about future sales growth than backward looking financials.
When insiders are buying, it’s a good sign – unless they happen to be New England bankers.
(Refers to the management of a number of Texas and New England banks who violated principle #13, continuing to add to their holdings right up until the very end.)
In business, competition is never as healthy as total domination.
A dominating monopoly company will generate much better returns for investors than several smaller companies fighting for market share.
All else being equal, invest in the company with the fewest color photographs in the annual report.
To understand this principle, all you need to do it look at the annual report of Berkshire Hathaway.
When even the analysts are bored, it’s time to start buying.
When analysts get bored by the company’s lack of progress, the company may be boring enough to buy.
Unless you’re a short seller or a poet looking for a wealthy spouse, it never pays to be pessimistic.
Cyclicals can be a great way to make a buck if you buy them at the bottom, so it helps to look for opportunity in depressed stocks, rather than think of all the reasons why a cyclical is going to take losses. Optimism is required.
Corporations, like people, change their names for one of two reasons: either they’ve gotten married, or they’ve been involved in some fiasco that they hope the public will forget.
If it’s the latter, it’s best to stay away.
Whatever the Queen is selling, buy it.
If countries privatize formal state-owned companies, they usually do so on such attractive terms that shareholders are almost guaranteed to make great profits.
Stay tuned for our Small-Cap Investing Guide part VII!