What We Can Learn from a Market Beating Portfolio

Money tree Ever heard of the St Agnes fund managers who impressed mutual fund legend Peter Lynch so much, he invited them over for a pizza-dinner at his office’s executive dining room?

For the record, Peter Lynch achieved returns of 29% per year for 13 years, turning every $1,000 entrusted to him into $27,000, before retiring as fund manager of Fidelity’s Magellan Fund in 1990.

But, what was so special about the St Agnes fund besides a combined portfolio return of 70% over 2 years from 1990 to 1991 while the S&P 500 Index only gained 26%? Well, the St Agnes fund managers were all children – 12 to 14 year-old kids to be exact – and by Lynch’s estimates, they had beaten 99 per cent of all professionally-managed equity mutual funds. How did they do it?

In Lynch’s book Beating the Street, he recounted how Joan Morrissey, a teacher in St Agnes, kick-started the investing-project because she wanted to teach financial literacy and investing to her students. Morrissey instilled two very important investing lessons into her students’ share-picking process (that we can learn from) that explained their success.

Lesson Number 1: Invest in What You Know

Morrissey’s students were divided into teams of four and they were given a theoretical sum of $250,000 to invest by constructing a portfolio of shares. But before any shares can be put into their portfolio, the students must first be able to ‘explain exactly what the company does’ to the class.

The students’ portfolios were laden with consumer-oriented companies like sports goods manufacturer Nike (NYSE: NKE), entertainment juggernaut Walt Disney (NYSE: DIS) and fast-food retailer Macdonald’s (NYSE: MCD). These are companies with goods and services that the students were intimately familiar with.

When we invest, we have to know how the company makes its profits. Only then, can we make logical guesses about a company’s profitability and financial stability in the long run. It is true that some companies’ operations can be a black box – like the off-balance sheet liabilities of financial institutions in the run-up to the global financial crisis of 07/09 – and still be lucrative investments. But, those are risks investors can choose to avoid.

The bottom line, as delivered by Peter Lynch is this, Never invest in any idea you can’t illustrate with a crayon”.

Lesson Number 2: Know the Numbers

The St Agnes students’ investing adventure started before the days of the internet and they had to rely on reading financial newspapers for their share-picking research. They were taught how to check the earnings of each company and to compare their relative strengths. It was important for the students to know the financials of the companies they wanted to pick.

When the students visited Peter Lynch, they gave him a stock tip that amazingly went on to double in price. The students had great first-hand experience with stationery manufactured by Pentech. But it was a study of the company’s financials, showing no long term debt, which convinced the students to recommend Pentech to Lynch.

Besides knowing what a company does, its financials are important too. Sad stories of shareholders losing money in companies that went bankrupt could have been re-written had those shareholders learnt how to read balance sheets for signs of crippling debt.

Foolish Final Thought

Look around your daily life for companies to invest in. Are you impressed with ION Orchard? Check out its owner, CapitaMalls Asia (SGX: JS8). Do you see more and more people taking buses and MRTs? You can find out more about public transport operators like SMRT Corporation (SGX: S53). What about popular restaurants, food courts and bread stalls? You might realise that Breadtalk Group (SGX: 5DA) owns many of such Food & Beverage franchises.

Understand what different companies are doing and know their numbers – there might be a great investment lurking in the corner. If a bunch of kids in St Agnes can do it, so can you.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore Contributor Chong Ser Jing doesn’t own shares in any companies mentioned.

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