An Investing Legend's Million-Dollar Insights: Part 1

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This article is the first in a five-part series from Fool U.K. that documents the share-picking strategies of Peter Lynch, the Fidelity fund manager who enjoyed average annual returns of 29% for 13 years. To read the other articles in this series, follow the links below.

LONDON -- "Investing is fun, exciting and dangerous if you don't do any work."

So said the man who provided investors with a 2,700% return over just 13 years while running Fidelity's Magellan Fund from 1977 to 1990. That's a stunning rate of return, which equates to a compound annual growth rate of around 29%.


Think what that could mean for you. If you have your sights set on the magical million for your own portfolio, you need to start with just 37,000 pounds to achieve 1 million pounds in 13 years -- if you can replicate that 29% annual return!

It's not easy to achieve returns like that, so it's worth listening to the man I'm talking about: Fidelity's star performer, Peter Lynch. You might also want to read this free Motley Fool report, "10 Steps To Making A Million In The Market," which outlines the types of shares that could compound your wealth. The report certainly inspired me to act!

Working the magic
Time and again, I return to Lynch and his investing insights. In two comprehensive how-to books, One Up On Wall Street and Beating The Street, he sets out his methods for buying, selling, and managing shares.

With hundreds of shares to follow in his investment fund, Peter Lynch followed his own advice and worked very hard. But the good news for private investors is his recommendation to concentrate on just a few quality holdings. The sister benefit of such a strategy is a reduced workload.

Much of Lynch's wisdom is familiar to investors, but with this article series, I'm attempting to dig a little deeper to discover how he managed his portfolio to achieve such impressive returns. Here's the first insight:

Lynch insight: A big winner may translate to a small gain in a large portfolio.                       

Lynch's golden key
I think Lynch outperformed his peers by better understanding the true nature of the businesses he owned -- that was his golden rule.

He sorted companies into six categories:

  • Slow growers.
  • Stalwarts.
  • Fast growers.
  • Cyclicals.
  • Turnarounds.
  • Asset Plays.

I'll look at what that means for investors shortly, but if you take nothing else from this series, take this insight and act on it:

Lynch insight: Understand shares by categorizing their underlying companies. 

Boomerang businesses
One slippery category has boomerang-style businesses that often seem to go nowhere in the longer term. But they keep out-foxing investors by going in disguise as something else.

I'm talking about cyclicals, those companies with sales and profits that expand and contract over and over again in regular -- but unpredictable -- fashion, dragging their share prices on the same nauseous roller-coaster ride.

To the unwary, their forward earnings projections can make them look like fast-growing companies on the up-leg, or their dividend yields and other value indicators can make them look like bargains at their cyclical peaks -- just before the next down-leg.

But don't be fooled by their disguise. The sales, profits and share prices of cyclicals can boomerang back to where they started, and below, in short order.

Perhaps the best way to identify them is by their financial records. Take plumbing supplies distributor Wolseley (ISE: WOS.L) , for example:

 

2007

2008

2009

2010

2011

Revenue (million pounds)16,22114,81414,44113,20313,558
Net profit (million pounds)474242(732)(366)281
Earnings per Share (pence)73212.84(348.2)(129.8)98.6

Profits plummeted into loss during the depths of the recent recession, and a peek at the share-price chart shows a fall from 60 pounds in 2006 to around 5 pounds in 2009: a disastrous plunge for any investor seduced into a long investment by the low P/E ratio and/or fat dividend yield during 2006.

A dilutive rights issue exacerbated the damage as the company raised funds to pay down some of its debt -- indeed, earnings per share may never return to former levels.

Contrast that to the results from a steadier company such as WmMorrison Supermarkets (ISE: MRW.L) over the same period:

 

2007

2008

2009

2010

2011

Revenue (million pounds)12,96914,52815,41016,47917,663
Net profit (million pounds)554460598632690
Earnings per Share (pence)20.6717.1622.3723.4326.03

Business here is less affected by economic cycles, a situation that is reflected in Morrison's longtime rising share price.

Cyclical profits
Timing investments to take advantage of the movements in cyclical shares can be difficult, but Peter Lynch did it well. In my second article, I'll explore his illuminating methodology for cyclical investing.

For now, though, let me just tell you that I'm 100% sold on how Peter Lynch invested his way to compound 29% returns. Indeed, I'm using his lessons -- plus the free 10 Steps To Making A Million In The Market report that I mentioned earlier -- to help take my own portfolio to the magic seven-digit milestone!

As I say the report is free -- so if you're an ambitious investor like me, you should download it today while it's still available.

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Further Motley Fool investment opportunities

The article An Investing Legend's Million-Dollar Insights: Part 1 originally appeared on Fool.com.

Kevin owns shares in Wm Morrison. The Motley Fool has adisclosure policy. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.

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