Beating the Street

1. Embrace Stocks Over Bonds: The Power of Long-Term Growth

Gentlemen who prefer bonds don't know what they're missing.

Stocks outperform bonds. Over the long term, stocks have historically provided significantly higher returns than bonds, CDs, or money market accounts. This is due to the fact that companies grow, increase profits, and raise dividends, whereas bonds offer a fixed rate of return.

• Over 64 years, a $100,000 investment in long-term government bonds would be worth $1.6 million, while the same amount invested in the S&P 500 would be worth $25.5 million.
• The odds of stocks outperforming bonds are six to one.

Don't be a nation of bondholders. Millions of people are devoted to collecting interest, which may or may not keep them slightly ahead of inflation, when they could be enjoying a 5-6 percent boost in their real net worth, above and beyond inflation, for years to come.

• Throughout the 1980s, the percentage of household assets invested in stocks declined, even as the stock market quadrupled in value.
• Most retirement accounts are heavily invested in money-market funds, bond funds, or equity income funds, rather than pure equity funds, which have historically provided the best long-term growth.

Long-term perspective is key. While there may be periods when bonds outperform stocks, these are rare and cannot make up for the huge advances made by stocks in the long run. If you hope to have more money tomorrow than you have today, you've got to put a chunk of your assets into stocks.

2. The Amateur Advantage: Simplicity and Local Knowledge Win

Never invest in any idea you can't illustrate with a crayon.

Amateurs can outperform professionals. Average investors, free from the rules and pressures that weigh down professional fund managers, have a natural advantage in the stock market. They can research companies in their spare time, invest in what they know, and stay in cash when no opportunity appeals to them.

• Investment clubs, made up of ordinary men and women, have consistently outperformed the S&P 500.
• Seventh graders at St. Agnes School produced a two-year investment record that Wall Street professionals can only envy.

Simplicity is key. The stockpicking methods of successful amateur investors are often much simpler and more rewarding than the complex techniques used by highly paid fund managers.

• Buy what you know about.
• If you can't explain what a company does, don't buy it.
• Focus on companies with room to grow.

Local knowledge pays off. Neighborhood investing, researching your own investments, and buying shares in great companies that Wall Street may have overlooked can lead to remarkable results. The remarkable record of local mutual savings banks and S&Ls is powerful evidence that neighborhood investing pays off.

3. Ignore the Noise: Weekend Worrying and Market Timing are Traps

You can't see the future through a rearview mirror.

Weekend worrying is a dangerous habit. The financial press often makes Wall Street types into celebrities, giving the amateur investor the false impression that he or she can't possibly hope to compete against so many geniuses.

• The financial press is full of reasons that mankind is doomed: global warming, global cooling, recession, inflation, illiteracy, the high cost of health care, etc.
• It is on weekends that people have extra time to ponder the distressing news that comes our way via TV stations or the daily newspaper.

Market timing is a fool's errand. Trying to predict the direction of the market and the economy is a waste of time. Even the experts can't agree on whether we are facing an imminent global depression or an economic upswing.

• The Barron's Roundtable, a group of supposed experts, can't agree on whether we are facing an imminent global depression or an economic upswing.
• The year the panel was the most optimistic about the future for the economy and the stock market was 1987, which ended with the famous 1000-point drop.

Focus on the long term. The key to making money in stocks is not to get scared out of them. It isn't the head but the stomach that determines the fate of the stockpicker. The skittish investor, no matter how intelligent, is always susceptible to getting flushed out of the market by the brush beaters of doom.

4. Mutual Fund Strategy: Diversify, Don't Overpay, and Stay the Course

As long as you're picking a fund, you might as well pick a good one.

Mutual funds are a solution for some. Equity mutual funds are the perfect solution for people who want to own stocks without doing their own research. Investors in equity funds have prospered handsomely in the past, and there's no reason to doubt they will continue to prosper in the future.

• There's no rule that says you can't own individual stocks and mutual funds.
• There's no rule that you can't own several mutual funds.

Diversify your fund holdings. It's best to divide your money among three or four types of stock funds (growth, value, emerging growth, etc.) so you'll always have some money invested in the most profitable sector of the market.

• When you add money to your portfolio, put it into the fund that's invested in the sector that has lagged the market for several years.
• You can also add a utility fund or an equity-and-income fund for ballast in a stormy market.

Don't overpay for bond funds. A bond fund offers no protection against higher interest rates, which is by far the greatest danger in owning a long-term IOU. Anyone who buys an intermediate-term government bond fund and pays the .75 percent in annual expenses could just as easily buy a 7-year Treasury bond, pay no fee, and get a higher return.

Stay the course. The short-term results of equity funds are less predictable, which is why you shouldn't buy equity mutual funds unless you know you can leave the money there for several years and tolerate the ups and downs.

5. Magellan's Lessons: Methodology, Mistakes, and the Power of Patience

You can't see the future through a rearview mirror.

Methodology over strategy. Lynch's stockpicking was entirely empirical, and he went sniffing from one case to another like a bloodhound that's trained to follow a scent. He cared much more about the details of a particular story than about whether his fund was underweighted or overweighted in a particular sector.

• He was attracted to a mystifying assortment of companies, the most notable absence being the chemical sector that he had researched so thoroughly as an analyst.
• He followed scents in every direction, proving that a little knowledge about a lot of industries is not necessarily a dangerous thing.

Mistakes are inevitable. Even the best stockpickers make mistakes. Lynch's biggest mistakes were selling Home Depot and Toys "R" Us too soon.

• He also had a habit of buying and selling stocks too frequently, which led to a high turnover rate in the fund.
• He learned that it's better to stick with a steady and consistent performer than to move in and out of funds, trying to catch the waves.

Patience is a virtue. The key to success in the stock market is to ignore the worries of the world long enough to allow your investments to succeed. It isn't the head but the stomach that determines the fate of the stockpicker.

• The skittish investor, no matter how intelligent, is always susceptible to getting flushed out of the market by the brush beaters of doom.
• You can lose money in a very short time but it takes a long time to make money.

6. The Art and Science of Stockpicking: Combining Research with Intuition

The stock market really isn't a gamble, as long as you pick good companies that you think will do well, and not just because of the stock price.

Stockpicking is both an art and a science. It requires a combination of quantitative analysis (balance sheets, earnings, growth rates) and qualitative judgment (understanding the business, its management, and its competitive landscape).

• Too much focus on measurement can be harmful, as it can lead to ignoring the human element of business.
• Too much reliance on intuition can lead to impulsive decisions and a lack of discipline.

Legwork is essential. Successful stockpicking requires a lot of legwork, including reading annual reports, visiting companies, and talking to management.

• You have to research the company before you put your money into it.
• You should not buy a stock because it's cheap but because you know a lot about it.

No pat formulas. There are no bells that ring when you've bought the right stock, and no matter how much you know about a company you can never be certain that it will reward you for investing in it. But if you know the factors that make a retailer or a bank or an automaker profitable or unprofitable, you can improve your odds.

7. Finding Value in the Unpopular: Distressed Industries and Overlooked Companies

You should not buy a stock because it's cheap but because you know a lot about it.

Look for opportunities in unloved sectors. A great company in a lousy industry is often a better investment than a mediocre company in a great industry.

• A great industry that's growing fast attracts too much attention and too many competitors.
• In a lousy industry, one that's growing slowly if at all, the weak drop out and the survivors get a bigger share of the market.

Focus on the fundamentals. When an industry is out of favor, it's important to focus on the fundamentals of the companies within it. Look for companies with strong balance sheets, low debt, and a history of profitability.

• You want to see, first, that sales and earnings per share are moving forward at an acceptable rate and, second, that you can buy the stock at a reasonable price.
• It is well to consider the financial strength and debt structure to see if a few bad years would hinder the company's long-term progress.

Be a contrarian. The best time to buy a stock is often when it is unpopular and the price has been driven down by fear and pessimism. This is when you can find the most attractive bargains.

8. Retail and Restaurant Insights: Putting Your Money Where Your Mouth Is

If you like the store, chances are you'll love the stock.

Retailers and restaurants are easy to understand. These are businesses that most people are familiar with, and it's easy to see which ones are doing well and which ones are struggling.

• You can do your own research by visiting stores and restaurants and observing the traffic, the merchandise, and the service.
• You can also get valuable insights from your family and friends, who are often the best customers of these businesses.

Look for companies with room to grow. A restaurant chain that succeeded in one region has an excellent chance of duplicating its success in another.

• When you invest in a stock, you'll know to invest in a company that has room to grow.
• When K mart went into all the big towns, Wal-Mart was doing even better because it went into all the small towns where there was no competition.

Focus on the fundamentals. Look for companies with a history of prosperity, in which earnings are on the rise, and that have a strong balance sheet.

• A good company usually increases its dividend every year.
• You want to see, first, that sales and earnings per share are moving forward at an acceptable rate and, second, that you can buy the stock at a reasonable price.

9. The Power of the "Privatized" Play: Government Garage Sales and Hidden Assets

When you invest in the stock market you should always diversify. You should invest in several stocks because out of every five you pick one will be very great, one will be really bad, and three will be OK.

Privatization can be a boon for investors. When governments sell off state-owned enterprises, they often structure the deals to be attractive to investors.

• The British have sold everything from the waterworks to the airlines, and these deals have generally been good for the buyers.
• The U.S. government has also sold off some assets, such as Conrail, which has been a successful investment.

Look for hidden assets. When a company is being sold off by the government, it may have hidden assets that are not immediately apparent.

• These assets may include valuable real estate, intellectual property, or a strong customer base.
• By doing your own research, you can uncover these hidden assets and profit from them.

Be wary of overhyped deals. Not all privatizations are created equal. Some may be overpriced or have hidden liabilities. It's important to do your own due diligence before investing in any company, even one that's being sold off by the government.

10. The Cyclical Game: Timing the Ups and Downs, and Knowing When to Exit

You can lose money in a very short time but it takes a long time to make money.

Cyclicals are a game of anticipation. The key to making money in cyclical stocks is to buy them when they are out of favor and sell them when they are popular.

• When the p/e ratios of cyclical companies are very low, it's usually a sign that they are at the end of a prosperous interlude.
• When the p/e ratios of cyclical companies are very high, it's usually a sign that they are at the beginning of a prosperous interlude.

Focus on the fundamentals. Before investing in a cyclical, make sure that the company has a strong balance sheet and the ability to survive a downturn.

• It is well to consider the financial strength and debt structure to see if a few bad years would hinder the company's long-term progress.
• You want to see, first, that sales and earnings per share are moving forward at an acceptable rate and, second, that you can buy the stock at a reasonable price.

Be prepared to sell. Cyclicals are not buy-and-hold investments. You have to be prepared to sell them when the cycle turns, even if the company is still making money.

• Never fall in love with a stock; always have an open mind.
• Just because a stock goes down doesn't mean it can't go lower.

11. The S&L Story: Finding Opportunity in the Midst of Crisis

You have to research the company before you put your money into it.

S&Ls are a misunderstood group. The S&L crisis of the 1980s created a lot of fear and pessimism about these institutions, but many S&Ls have survived and are now thriving.

• The key is to distinguish between the bad guys, the greedy guys, and the Jimmy Stewarts.
• The Jimmy Stewart S&Ls are the ones that have quietly been making a profit all along, by sticking to their simple function of taking in deposits and making residential mortgage loans.

Focus on the fundamentals. When evaluating an S&L, look for a high equity-to-assets ratio, low nonperforming loans, and a low percentage of high-risk real estate assets.

• You want to see, first, that sales and earnings per share are moving forward at an acceptable rate and, second, that you can buy the stock at a reasonable price.
• It is well to consider the financial strength and debt structure to see if a few bad years would hinder the company's long-term progress.

Look for bargains. Many S&Ls are selling at a discount to their book value, which means that you are getting more assets for your money.

• You should not buy a stock because it's cheap but because you know a lot about it.
• You should not just pick a stock—you should do your homework.

12. The Importance of the Six-Month Checkup: Staying on Top of Your Investments

Never fall in love with a stock; always have an open mind.

Regular reviews are essential. A healthy portfolio requires a regular checkup, perhaps every six months or so. This is not simply a matter of looking up the stock price in the newspaper, but of reviewing the story of each company in your portfolio.

• You have to research the company before you put your money into it.
• You should not just pick a stock—you should do your homework.

Ask the right questions. When reviewing a stock, ask yourself: (1) is the stock still attractively priced relative to earnings, and (2) what is happening in the company to make the earnings go up?

• If the story has gotten better, you might want to increase your investment.
• If the story has gotten worse, you can decrease your investment.
• If the story's unchanged, you can either stick with your investment or put the money into another company with more exciting prospects.

Don't be afraid to change your mind. The stock market is a fluid situation in which nothing is absolutely certain. You have to be willing to change your mind about a stock if the story changes.

• Never fall in love with a stock; always have an open mind.
• Just because a stock goes down doesn't mean it can't go lower.

Last updated: January 15, 2025