3 valuable lessons from a legendary fund manager

I re-read Peter Lynch’s seminal text on investing, One Up On Wall Street, for about the 7th time over the Easter weekend. That’s a lot of re-reads, I know.

Partly it’s because his writing style is so approachable– I wish I could write like that – but mostly it’s because his fund returned 29% per annum over 13 years, and you can never soak up enough advice from people with that kind of record.

Here are the 3 lessons that stood out most to me on this occasion:

It’s impossible to find a general rule that applies to all companies

“Basing a strategy on general maxims, such as ‘Sell when you double your money’ or ‘cut your losses by selling when the price falls 10%’ is absolute folly.”

Different companies offer different things. Lynch has his own names for types of stocks, but in simple terms a company like Insurance Australia Group Ltd (ASX: IAG) is very different to a Nearmap Ltd (ASX: NEA). You’ll be lucky to double your money on IAG in a few years, whereas a growth business like Nearmap could potentially become many times larger over the long term. IAG has a much stronger balance sheet and is more resilient to a downturn, while Nearmap is much more financially vulnerable.

Thus applying the same rules (whatever they might be) to both Insurance Australia Group and Nearmap is being arbitrary and likely to hurt your investing.

It is very difficult to predict earnings

According to Mr Lynch, when even professional analysts with qualifications and years of experience get it wrong regularly, the amateur investor hasn’t got a prayer of predicting earnings successfully. Instead, what investors can do is find out how the company plans to increase earnings, and follow that ‘story’ to see the progress.

One good example of a ‘story’ stock is Greencross Limited (ASX: GXL). By co-locating vets and pet groomers inside its retail stores, the company can increase the number of customers for the retail business, while also establishing a vet business at a lower cost. There’s a report on this every 6 months, making it easy for shareholders to follow along.

If you use stop-losses, you are agreeing to sell the shares at a lower price than you paid for them

Peter Lynch has strong feelings about stop-losses (which automatically sell your shares after they decline, say, 10%, preventing them from falling further) and the topic has proved divisive on the Foolish forums as well. Different strokes for different folks and all that, but if you’re buying quality merchandise at an attractive price, and take a long term view, there is no need to sell just because share prices fall. You wouldn’t automatically sell your new car just because the same model went on sale at a lower price 2 weeks after you bought it.

Not to mention the additional sales caused by stop-losses will result in a lot more trading fees and paperwork come tax time. It’s easy to fall into the trap of saying, in Lynch’s words, “I was wrong, that sucker’s going down” when share prices fall, but resisting that line of thought will help your returns over the long term.

And if you found those tips useful, here are some more lessons we can learn from another legendary investor...

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Motley Fool contributor Sean O'Neill owns shares of Nearmap Ltd. The Motley Fool Australia owns shares of Greencross Limited and Nearmap Ltd. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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