The Easiest Way for ANYONE to Understand the Share Market

I recently chanced upon a rare video of investing legend Peter Lynch which was first filmed in 1994. In it, Lynch shared a fascinating anecdote which I think is the easiest way for anyone to understand what the share market is all about.

But first, why is Lynch considered an investing legend? That’s because of his exploits with the Fidelity Magellan mutual fund (the equivalent of unit trusts here) in the USA. Lynch was the manager of the fund from 1977 to 1990 during which he clocked compounded annualised returns of 29%.

To put into perspective how incredible that achievement was, consider that every $1,000 entrusted to Lynch in 1977 would have become $27,000 by the end of his tenure. He managed that even when the S&P500 (a broad stock market index in the USA akin to the Straits Times Index (SGX: ^STI) here) gained only 208% from the start of 1977 to the end of 1990.

Coming back to the video, around the 14:20 min mark, Lynch said this:

I’m trying to convince people there is a method. There are reasons for stocks to go up. This is very magic: it’s a very magic number, easy to remember. Coca-cola is earning 30 times per share what they did 32 years ago; the stock has gone up 30 fold. Bethlehem Steel is earning less than they did 30 years ago – the stock is half its price 30 years ago. Stocks are not lottery tickets. There’s a company behind every stock – if the company does well, the stock does well. It’s not that complicated.”

For me, that’s the best and simplest encapsulation of what the share market is all about.

A few weeks ago, I had looked at some of Singapore’s best shares over the past decade from the start of 2004 till 1 June 2014. Although the relationship between the best performers’ earnings growth and share price gains weren’t as beautifully symmetrical as what Lynch had said about Coca-Cola, the relationship that exists is still unmistakable. Here’s what I mean:

Share Total return* EPS growth**
Ezion Holdings  (SGX: 5ME) 4,734% 1671%
United Overseas Australia  (SGX: EH5) 2,931% 366%
Aspial Corporation  2,445% 759%
Baker Technology 2,095% 38%
Low Keng Huat (Singapore) 2,067% 849%
Sim Lian Group 1,566% 771%
CWT 1,413% 5620%
Raffles Medical Group 1,274% 722%
Vicom 1,257% 228%
MTQ Corporation 1,190% 838%
* Total returns take into account all dividends, rights issues, spin-offs and splits. The dates involved are from 1 Jan 2004 till 1 June 2014.
**EPS (earnings per share) growth between 1 Jan 2004 and 1 June 2014

Source: S&P Capital IQ

For a local and more current version of Bethlehem Steel, check out Surface Mount Technology (Holdings) (SGX: Q7Q) and Metech International (SGX: QG1), two of Singapore’s worst shares over the past decade. The two companies were earning 146 and 30.7 Singapore cents per share respectively back at the start of 2004. By 1 June 2014, the two companies’ profits had shrunk (almost beyond recognition) to 0.57 and 0.003 cents.

What about their share prices? Within the same time frame, Surface Mount Technology’s shares had collapsed from S$13.55 to S$0.019 while Metech International’s price had been slashed from S$2.488 to S$0.014. Again, the relationship between a company’s long-term corporate performance and its subsequent share price return is painfully obvious.

Foolish Bottom Line

Like Peter Lynch, we here at The Motley Fool Singapore are trying to convince all Singaporeans that there is a method to the share market. And, it’s not about predicting interest rates or peering at magic charts – it’s about understanding a company and how its business might perform over the long-term future.

Click here now for your FREE subscription to Take Stock Singapore, The Motley Fool’s free investing newsletter. Written by David Kuo, Take Stock Singapore tells you exactly what’s happening in today’s markets, and shows how you can GROW your wealth in the years ahead.  

The Motley Fool’s purpose is to help the world invest, better. Like us on Facebook  to keep up-to-date with our latest news and articles.

The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing owns shares in Raffles Medical Group.