In 1997, Peter Lynch wrote a great article entitled, Use Your Edge. I’ve posted an excerpt of it below.
So, what advice would I give to someone with $1 million to invest? The same I’d give to any investor: Find your edge and put it to work by adhering to the following rules:
- With every stock you own, keep track of its story in a logbook. Note any new developments and pay close attention to earnings. Is this a growth play, a cyclical play, or a value play? Stocks do well for a reason and do poorly for a reason. Make sure you know the reasons.
- Pay attention to facts, not forecasts.
- Ask yourself: What will I make if I’m right, and what could I lose if I’m wrong? Look for a risk-reward ratio of three to one or better.
- Before you invest, check the balance sheet to see if the company is financially sound.
- Don’t buy options, and don’t invest on margin. With options, time works against you, and if you’re on margin, a drop in the market can wipe you out.
- When several insiders are buying the company’s stock at the same time, it’s a positive.
- Average investors should be able to monitor five to ten companies at a time, but nobody is forcing you to own any of them. If you like seven, buy seven. If you like three, buy three. If you like zero, buy zero.
- Be patient. The stocks that have been most rewarding to me have made their greatest gains in the third or fourth year I owned them. A few took ten years.
- Enter early — but not too early. I often think of investing in growth companies in terms of baseball. Try to join the game in the third inning, because a company has proved itself by then. If you buy before the lineup is announced, you’re taking an unnecessary risk. There’s plenty of time (10 to 15 years in some cases) between the third and the seventh innings, which is where the 10- to 50-baggers are made. If you buy in the late innings, you may be too late.
- Don’t buy “cheap” stocks just because they’re cheap. Buy them because the fundamentals are improving.
- Buy small companies after they’ve had a chance to prove they can make a profit.
- Long shots usually backfire or become “no shots.”
- If you buy a stock for the dividend, make sure the company can comfortably afford to pay the dividend out of its earnings, even in an economic slump.
- Investigate ten companies and you’re likely to find one with bright prospects that aren’t reflected in the price. Investigate 50 and you’re likely to find 5.
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