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Two investment principles from Peter Lynch that I think will make you a better investor

Peter Lynch is a value investor who has devoted a lot of time and energy to educating people about the stock market. Here are two of his famous investing principles that could make you a better investor.

Know your strengths

The price of a stock is ultimately related to the ability of the underlying business to generate cash for its shareholders. In the short term, that relationship is sometimes disrupted, but in the long run it is borne out. Therefore, if you know whether a company’s product or service will become popular before the market realises it, you can buy the stock at a discount to future value. How do you know whether a product will sell well or not? You may find that you know a lot more than you think you do. 

Lynch is a great believer in the idea that ordinary people can invest just as well as professionals, provided they stick to what they know. For instance, a mechanic probably has a lot more in-depth knowledge of the automobile market than an analyst at a bank does. Similarly, a biochemist will have more insight into the pharmaceutical industry than a professional money manager. The trick is taking what you are already good at and focusing on that, and having the discipline to not get swept along by the next investing fad.

Control your emotions and know yourself

Peter Lynch famously said: “The key organ is not the brain. It’s the stomach”. Much like Warren Buffett, Lynch does not consider intelligence to be a particularly important factor in investment success. However, he considered emotional fortitude to be of paramount importance. Not everyone is cut out to be a long-term investor. Deploying capital at a time when everyone else is scared and selling their positions is not an easy thing to do, even if you know intellectually that it is the right thing to do. At the end of the day, humans are animals who instinctively follow the herd. 

Seth Klarman, another well-known value investor, likes to say that value investing is fundamentally an arrogant act – you have to stand there and say “I’m going to buy this when no one else wants to buy it because I believe that I know better than everyone else”.

Having self-confidence (and the correct degree of arrogance) is one challenge. Being humble is another. It’s impossible to be right 100% of the time. It’s difficult to be correct even 60% of the time. This means that you must have the humility and presence of mind to say “you know what, I was wrong on this one”. Sometimes it is better to accept defeat and move on, especially when new information comes out that disproves your thesis on a stock. And after all, it doesn’t matter how often you are right. What matters is how big you win.

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Neither Stepan nor The Motley Fool UK have a position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.