The following is an article written by Peter Lynch we found at the following link. We are not sure when the article was written, but wanted to include it in our Peter Lynch page.

Use Your Edge

By Peter Lynch

What’s the best way to invest $1

million? Tip one: Don’t buy

stocks on tips alone. If your                                         Amateurs

only reason for picking a stock                                    can beat

is that an expert likes it, then                                       the Streat

what you really need is paid                                        because, well,

professional help. Mutual funds                                   they’re amateurs.

are a great idea (I ran one

once) for folks who want this                                      Look around

sort of assistance at a                                                you for

reasonable price.                                                       good stocks. Down

the road, you

Still, I’m not convinced that                                        won’t regret it.

having 4,000 equity funds in

this country is an entirely                                           You didn’t

positive development. True, most                              need a

of the cash flooding into these                                   Ph.D. to figure

funds comes from retirement and                              out that Microsoft

pension contributions, where                                      was going to be

people can’t pick their own                                         powerful.

stocks. But some of it also has

to be pouring in from former                                       If you

stock pickers who failed to                                          missed the

invest wisely on their own                                           boat on Microsoft,

account and have given up                                         there are still

trying.                                                                          other technology

stocks you can buy

———————————                                           into.

One of the oldest sayings on

Wall Street is “Let your winners                                   There are

run, and cut your losers.”                                            ways you

———————————                                           can keep yourself

from gaining on

When people find a profitable                                      the good growth

activity — collecting stamps or                                     companies.

rugs, buying old houses and

fixing them up — they tend to                                      Sometimes

keep doing it. Had more                                              depressed

individuals succeeded at                                             industries can

individual investing, my guess                                     produce high

is they’d still be doing it. We                                        returns.

wouldn’t see so many converts to

managed investment care,                                         Retail and

especially not in the greatest                                       restaurants

bull market in U.S. history.                                           haven’t been

Halley’s comet may return ten                                     performing well —

times before we get another                                        but they’re two of

market like this.                                                            Lynch’s favorite


If I’m right, then large numbers

of investors must have lost                                          You can

money outright or badly trailed                                    even find

a market that’s up eightfold                                         bargain stocks in

since 1982. How did so many do                                 this market that

so poorly? Maybe they traded a                                  have been

new stock every week. Maybe they                             overlooked.

bought stocks in companies they

knew little about, companies                                        Wondering

with shaky prospects and bad                                      when you

balance sheets. Maybe they                                        should exit the

didn’t follow these companies                                      market? Use

closely enough to get out when                                   Lynch’s rule of

the news got worse. Maybe they                                 thumb.

stuck with their losers through

thin and thinner, without                                               Stocks do

checking the story. Maybe they                                    well for a

bought stock options. Whatever                                   reason, and poorly

the case, they failed at                                                 for a reason.

navigating their own course.

Amateurs can beat the Streat
because, well, they’re amateurs.

At the risk of repeating myself,
I’m convinced that this type of
failure is unnecessary — that
amateurs can not only succeed on
their own but beat the Street by
(a) taking advantage of the fact
that they are amateurs and (b)
taking advantage of their
personal edge. Almost everyone
has an edge. It’s just a matter
of identifying it.

While a fund manager is more or
less forced into owning a long
list of stocks, an individual
has the luxury of owning just a
few. That means you can afford
to be choosy and invest only in
outfits that you understand and
that have a superior product or
franchise with clear
opportunities for expansion. You
can wait until the company
repeats its successful formula
in several places or markets
(same-store sales on the rise,
earnings on the rise) before you
buy the first share.

If you put together a portfolio
of five to ten of these high
achievers, there’s a decent
chance one of them will turn out
to be a 10-, a 20-, or even a
50-bagger, where you can make
10, 20, or 50 times your
investment. With your stake
divided among a handful of
issues, all it takes is a couple
of gains of this magnitude in a
lifetime to produce superior

One of the oldest sayings on
Wall Street is “Let your winners
run, and cut your losers.” It’s
easy to make a mistake and do
the opposite, pulling out the
flowers and watering the weeds.
Warren Buffett quoted me on this
point in one of his famous
annual reports (as thrilling to
me as getting invited to the
White House). If you’re lucky
enough to have one golden egg in
your portfolio, it may not
matter if you have a couple of
rotten ones in there with it.
Let’s say you have a portfolio
of six stocks. Two of them are
average, two of them are below
average, and one is a real
loser. But you also have one
stellar performer. Your
Coca-Cola, your
Gillette. A stock that
reminds you why you invested in
the first place. In other words,
you don’t have to be right all
the time to do well in stocks.
If you find one great growth
company and own it long enough
to let the profits run, the
gains should more than offset
mediocre results from other
stocks in your portfolio.

Look around you for good stocks.
Down the road, you won’t regret

A lot of people mistakenly think
they must search far and wide to
find a company with this sort of
potential. In fact, many such
companies are hard to ignore.
They show up down the block or
inside the house. They stare us
in the face.

This is where it helps to have
identified your personal
investor’s edge. What is it that
you know a lot about? Maybe your
edge comes from your profession
or a hobby. Maybe it comes just
from being a parent. An entire
generation of Americans grew up
on Gerber’s baby food,
and Gerber’s stock was a
100-bagger. If you put your
money where your baby’s mouth
was, you turned $10,000 into $1
million. Fifty-baggers like
Home Depot,
Wal-Mart, and Dunkin’
Donuts were obvious success
stories to large crowds of
do-it-yourselfers, shoppers, and
policemen. Mention any of these
at a party, though, and you’re
likely to get the predictable
reaction: “Chances like that
don’t come along anymore.”

Ah, but they do. Take
Microsoft — I wish I

You didn’t need a Ph.D. to
figure out that Microsoft was
going to be powerful.

I avoided buying technology
stocks if I didn’t understand
the technology, but I’ve begun
to rethink that rule. You didn’t
need a Ph.D. in programming to
recognize the way computers were
becoming a bigger and bigger
part of our lives, or to figure
out that Microsoft owned the
rights to MS-DOS, the operating
system used in a vast majority
of the world’s PCs.

It’s hard to believe the
almighty Microsoft has been a
public company for only 11
years. If you bought it during
the initial public offering, at
78 cents a share (adjusted for
splits), you’ve made 100 times
your money. But Apple was the
dominant company at the time, so
maybe you waited until 1988,
when Microsoft had had a chance
to prove itself.

By then, you would have realized
that IBM and all its
clones were using Microsoft’s
operating system, MS-DOS. IBM
and the clones could fight it
out for market share, but
Microsoft would prosper
regardless of who won. This is
the old combat theory of
investing: When there’s a war
going on, don’t buy the
companies that are doing the
fighting; buy the companies that
sell the bullets. In this case,
Microsoft was selling the
bullets. The stock has risen
25-fold since 1988.

The next time Microsoft might
have got your attention was
1992, when Windows 3.1 made its
debut. Three million copies were
sold in six weeks. If you bought
the stock on the strength of
that product, you’ve quadrupled
your money to date. Then, at the
end of 1995, Windows 95 was
released, with more than 7
million copies sold in three
months and 40 million copies as
of this writing. If you bought
the stock on the Windows 95
debut, you’ve doubled your

If you missed the boat on
Microsoft, there are still other
technology stocks you can buy

Many parents with children in
college or high school (I’m one
of them) have had to step around
the wiring crews as they
installed the newfangled
campuswide computer networks.
Much of this work is being done
by Cisco Systems, a company that
recently wired two campuses my
daughters have attended. Cisco
is another opportunity a lot of
people had a chance to notice.
Its earnings have been growing
at a rapid rate, and the stock
is a 100-bagger already. No
matter who ends up winning the
battle of the Internet, Cisco is
selling its bullets to various

Computer buyers who can’t tell a
microchip from a potato chip
still could have spotted the
intel inside label on every
machine being carried out of the
computer stores. Not
surprisingly, Intel has
been a 25-bagger to date: The
company makes the dominant
product in the industry.

Early on, it was obvious Intel
had a huge lead on its
competitors. The Pentium scare
of 1994 gave you a chance to
pick up a bargain. If you bought
at the low in 1994, you’ve more
than quintupled your investment,
and if you bought at the high,
you’ve more than quadrupled it.

Physicians, nurses, candy
stripers, patients with heart
problems — a huge potential
audience could have noticed the
brisk business done by
medical-device manufacturers
Medtronics, a 20-bagger, and
Saint Jude Medical, a 30-bagger.

There are ways you can keep
yourself from gaining on the
good growth companies.

There are two ways investors can
fake themselves out of the big
returns that come from great
growth companies.

The first is waiting to buy the
stock when it looks cheap.
Throughout its 27-year rise from
a split-adjusted 1.6 cents to
$23, Wal-Mart never looked cheap
compared with the overall
market. Its price-to-earnings
ratio rarely dropped below 20,
but Wal-Mart’s earnings were
growing at 25 to 30 percent a
year. A key point to remember is
that a p/e of 20 is not too much
to pay for a company that’s
growing at 25 percent. Any
business that can manage to keep
up a 20 to 25 percent growth
rate for 20 years will reward
shareholders with a massive
return even if the stock market
overall is lower after 20 years.

The second mistake is
underestimating how long a great
growth company can keep up the
pace. In the 1970s I got
interested in McDonald’s.
A chorus of colleagues said
golden arches were everywhere
and McDonald’s had seen its best
days. I checked for myself and
found that even in California,
where McDonald’s originated,
there were fewer McDonald’s
outlets than there were branches
of the Bank of America.
McDonald’s has been a 50-bagger

These “nowhere to grow” stories
come up quite often and should
be viewed skeptically. Don’t
believe them until you check for
yourself. Look carefully at
where the company does business
and at how much growing room is
left. I can’t predict the future
of Cisco Systems, but it doesn’t
suffer from a lack of potential
customers: Only 10 to 20 percent
of the schools have been wired
into networks, and don’t forget
about office buildings,
hospitals, and government
agencies nationwide.
Petsmart is hardly at the
end of its rope — its 320
stores are in only 34 states.

Whether or not a company has
growing room may have nothing to
do with its age. A good example
is Consolidated Products,
the parent of the Steak & Shake
chain that’s been flipping
burgers since 1934. Steak &
Shake has 210 outlets in only 12
states; 78 of the outlets are in
St. Louis and Indianapolis.
Obviously, the company has a lot
of expansion ahead of it. With
160 continuous quarters of
increased earnings over 40
years, Consolidated has been a
steady grower and a terrific
investment, even in a lousy
market for fast food in general.

Sometimes depressed industries
can produce high returns.

The best companies often thrive
even as their competitors
struggle to survive. Until
recently, the airline sector has
been a terrible place to put
money, but if you had invested
$1,000 in Southwest
Airlines in 1973, you would have
had $460,000 after 20 years. Big
Steel has disappointed investors
for years, but Nucor has
generated terrific returns.
Circuit City has done
well as other electronics
retailers have suffered. While
the Baby Bells have toddled, a
new competitor, WorldCom,
has been a 20-bagger in seven

Depressed industries, such as
broadcasting and cable
television, telecommunications,
retail, and restaurants, are
likely places to start a
research list of potential
bargains. If business improves
from lousy to mediocre,
investors are often rewarded,
and they’re rewarded again when
mediocre turns to good and good
turns to excellent. Oil drillers
are in the middle of such a
recovery, with some stocks
delivering tenfold returns in
the past 18 months. Yet it took
a decade of lousy before they
even got to mediocre. Readers of
my column in Worth learned of
the potential in this
long-suffering sector in
February 1995.

Retail and restaurants haven’t
been performing well — but
they’re two of Lynch’s favorite

Retail and restaurants are two
of the worst-performing
industries in recent memory, and
both are among my favorite
research areas. I’ve taken a
beating in a number of retail
stocks (some of which I still
like and have continued to buy),
but the general decline hasn’t
stopped Staples, Borders,
Petsmart, Finish Line,
and Pier 1 Imports from
rewarding shareholders. Two of
my daughters and my wife,
Carolyn, have continued to shop
at Pier 1, reminding me of its
popularity. The stock has
doubled in the past 18 months.

A glut in casual-dining outlets
didn’t hurt Outback
Steakhouse, and a surplus of
pizza parlors didn’t bother
Papa John’s, whose stock
was a double last year.
CKE Restaurants — whose
operations include the Carl’s
Jr. restaurants — has been a
profitable turnaround play in

You can even find bargain stocks
in this market that have been

So far, we’ve been talking about
growth companies on the move,
but even in this so-called
extravagant market, there are
plenty of bargains among the
laggards. Of the nearly 4,000
IPOs in the past five years,
several hundred have missed the
rally on Wall Street. From the
class of 1995, 37 percent, or
202 companies, are selling below
their IPO price. From the class
of 1996, 33 percent, or 285, now
trade below their offering
price. So much for the average
investor’s never having a chance
to profit from an offering. In
more than half the cases, you
can wait a few months and buy
these stocks cheaper than the
institutions that were cut in on
the original deals.

As the Dow has hit new records
week after week, many small
companies have been ignored. In
1995 and 1996, the Standard &
Poor’s 500 Stock Index was up 69
percent, but the Russell 2000
index of smaller issues was up
only 44 percent. And while the
Nasdaq market rose 25 percent in
1996, a lot of this gain can be
attributed to just three stocks:
Intel, Microsoft, and Oracle.
Half the stocks on the Nasdaq
were up less than 6.9 percent
during 1996.

That’s not to say owning these
laggards will protect you if the
bottom drops out of the market.
If that happens, the stocks that
didn’t go up will go down just
as hard and fast as the stocks
that did. I learned that lesson
in the 1971Ð73 bear market.
Before the selling was over,
companies that looked cheap by
any measure got much cheaper.
McDonald’s dropped from $15 a
share to $4. I thought Kaiser
Industries was a steal at $13,
but it also fell to $4. At that
point, this asset-rich
conglomerate, with holdings in
aluminum, steel, real estate,
cement, fiberglass, and
broadcasting, was trading at a
market value equal to the price
of four airplanes.

Wondering when you should exit
the market? Use Lynch’s rule of

Should we all exit the market to
avoid the correction? Some
people did that when the Dow hit
3000, 4000, 5000, and 6000. A
confirmed stock picker sticks
with stocks until he or she
can’t find a single issue worth
buying. The only time I took a
big position in bonds was in
1982, when inflation was running
at double digits and long-term
U.S. Treasurys were yielding 13
to 14 percent. I didn’t buy
bonds for defensive purposes. I
bought them because 13 to 14
percent was a better return than
the 10 to 11 percent stocks have
returned historically. I have
since followed this rule: When
yields on long-term government
bonds exceed the dividend yield
on the S&P 500 by 6 percent or
more, sell stocks and buy bonds.
As I write this, the yield on
the S&P is about 2 percent and
long-term government bonds pay
6.8 percent, so we’re only 1.2
percent away from the danger
zone. Stay tuned.

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.

Stocks do well for a reason, and
poorly for a reason.

*Pay attention to facts, not

*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

*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

*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

*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

*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.

Peter Lynch owns shares in the
following companies mentioned
above: Outback Steakhouse, Pier
1 Imports, Consolidated
Products, Staples, and WorldCom.

Read “How to Invest a Million”
in its entirety in the March
1997 issue of Worth (on
newsstands today), or in the
Worth archives on this site.