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Where to Find the Best Returns in the Share Market

As investors, we all want to find the best returns we can in the share market. One way to do so is to learn from the masters of investing.

Peter Lynch was the head of the US-based Fidelity Magellan fund in 1977, where he managed to deliver 29% annualized returns for his clients over 13 years. To put this into perspective, every $1,000 invested into his fund would have turned into $27,200 over his 13 year tenure.

In a 1990 article on Money Magazine, the investing maestro had many thoughts to share that are very useful for the individual investor. In particular, Mr. Lynch had one insight on where the “best returns” of the share market came from. He quipped:

“People want instant gratification, but that’s a guaranteed way to lose money in stock investing. From one year to the next, the stock market is a coin flip: it can go up or down. The real money in stocks is made in the third, fourth and fifth year of your investment, because you are participating in the company’s earnings, which grow over time.”

Putting Lynch to the test

Yesterday, I wrote about VICOM Limited (SGX:V01). In the article, I shared the ten year share returns for the vehicle test and inspection company. This table is reproduced, here:

Date
(31 December)
Share price Year-on-year share price growth Compounding effect
2004 S$0.96
2005 S$0.93 -3% -3.1%
2006 S$1.22 31% 27.1%
2007 S$1.82 49% 89.6%
2008 S$1.50 -18% 56.3%
2009 S$2.18 45% 127.1%
2010 S$2.93 34% 205.2%
2011 S$3.51 20% 265.6%
2012 S$4.89 39% 409.4%
2013 S$4.90 0% 410.4%

S ource: Google Finance

From this example, it would appear that Mr. Lynch’s observation rings true. From 31 December 2004, it was only in the fifth year when the share price returns (excluding dividends) of VICOM crossed the 100% mark. From there, the share price returns were more exciting. Its share price returns crossed the 200% mark by the following year, and subsequently, the 400% mark by the third year after 31 December 2009.

Wow, what happened here?

The explanation to this disproportionate distribution of returns comes from the power of compounding. This is shown in the table below. If we start with $1,000 cash to invest, it would take 100% in returns to reach $2,000. From there, it takes 50% from $2,000 to reach $3,000. Then, it takes 33.3% from $3,000 to $4,000. You get the picture. It takes less and less in percentage gain to get the next 100% returns on your original amount.

Amount of cash Percentage returns needed to reach next 100% in returns
$1,000
$2,000 100.0%
$3,000 50.00%
$4,000 33.33%
$5,000 25.00%
$6,000 20.00%
$7,000 16.67%
$8,000 14.29%
$9,000 12.50%
$10,000 11.11%

And, the good news is that the percentage hurdle for the next bagger just continues on downwards from there.This might be why Peter Lynch quoted the third, fourth, and fifth year as where the real returns on your money is made. The percentage hurdle to the next bagger shrinks as the performance of a company progresses upwards. By the 9th bagger (shown as $9,000 here), all it took would be little over 11% to gain another $1,000, and reach $10,000.

Foolish Take away

The key here is to keep doing what a Foolish investor should be doing. And, that is to focus on the business behind the ticker and to keep an eye out for the addressable market ahead for the company.

If we find that few multi-bagging companies in our lifetime, the best thing to do might be to “water the flowers”, and let time do its compounding work. In conclusion, my fellow Fool Morgan Housel, may have summed it up aptly when he observed the disproportionate change in net worth of another investing maestro, Warren Buffett:

“Warren Buffett is a great investor, but what makes him rich is that he’s been a great investor for two thirds of a century. Of his current $60 billion net worth, $59.7 billion was added after his 50th birthday, and $57 billion came after his 60th. If Buffett started saving in his 30s and retired in his 60s, you would have never heard of him. His secret is time.”

I couldn’t have said it any better. For more investing insights, sign up now for a FREE subscription to The Motley Fool’s weekly investing newsletter,  Take Stock Singapore. Written by David KuoTake Stock Singapore tells you exactly what’s happening in today’s markets, and shows how you can grow your wealth in the years ahead.

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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 Chin Hui Leong doesn’t own shares in any companies mentioned.