Let's be real: In the back of every investor's mind is the hope that the stocks they invest in will turn into home runs. Some homers might be a good return in a short period of time, but for many investors, home runs are also stocks that turn into multi-baggers over a longer investing time horizon.
If you are a new investor or are ready to dedicate more time to finding those home runs, I would definitely recommend trying to learn from the wisdom of Peter Lynch.
Lynch is legendary for heading up Fidelity's Magellan Fund, which he grew from $18 million in assets in 1977 when he took over to an astounding $14 billion of assets by the time he left the fund just 13 years later in 1990. That equates to an average annual return of 29.2%. Let's take a look at Lynch's advice for finding home runs in the stock market.
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Look under the radar
In a recent interview with Yahoo! Finance, Lynch discussed three strategies he has used throughout his career for finding home run stocks.
One strategy is to buy smaller stocks. Small stocks often slide under the radar and aren't covered by analysts, which allows them to escape the notice of the institutional money that can really make the share price move. But it also provides retail investors an opportunity to find these potential home runs before the smart money does and get in at a very attractive entry point.
One example Lynch gave is his investment in Au Bon Pain, which acquired the St. Louis Bread Company for $23 million in 1993 and then changed the name to Panera, a well-known brand today. The company grew and was eventually acquired and taken private by JAB Holding for $7.5 billion.
Another strategy Lynch has used in the past is what he calls surprise stories, which are companies that make money in a way that doesn't necessarily align with its core business model. One example is Lynch's investment in Stop & Shop, a grocery store near where Lynch lived in Boston.
Describing Stop & Shop's business model, Lynch said:
They make no money in milk, no money in bread, and [on] a lot of things they occasionally break even. But if you buy a birthday card for your mother or your kids, you have no idea what a good deal it is for them. There's a great profit margin on her birthday card for the grocery store -- two or three times the margin, plus they added a drugstore to create traffic. It was a 10-bagger. And what a shock.
The third strategy Lynch discussed is turnaround stories. Lots of times, companies will get into a bad financial position or will see their business model and competitive moat break down, causing investors to leave them for dead.
But there are plenty of times when management can engineer a turnaround, presenting a great entry point for investors that spot the turnaround in the making. This could involve a company that takes on too much debt but then finds a way to pay down a bunch of that debt, or perhaps a company finds a new use case for its product or service that becomes lucrative.
Said Lynch: "You don't need a lot of these in a lifetime. When things go from terrible to semi-terrible to OK, you can make a lot of money."
Stay curious, and stay patient
A lot of what Lynch is describing involves staying curious and staying patient. Curiosity means looking at stocks that aren't in the news every day or aren't on the big analyst coverage lists.
And while you can sometimes time these things right, it will often take time for the market to fully recognize a scenario in which investors are acting irrationally. But if you stay positive and do enough due diligence to confirm that your investment thesis is still intact, it's only a matter of time before the market notices.
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Bram Berkowitz has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
