Peter Lynch: How to Turn $10,000 Into $100,000 in the Stock Market

The goal of this video is to help you find stocks that have 10x return potential. One of my favorite investors of all time, Peter Lynch, calls these type of stocks "10 baggers." These are the type of investments that pay off so well that they make investors legendary, like Peter Lynch with his investment in Dunkin' Donuts or Warren Buffett with his investment in Coca-Cola. Peter Lynch identified and invested in numerous 10 baggers when he was the manager of the Fidelity Magellan Fund from 1977 to 1990.

As a result, the fund grew from 18 million dollars in assets when Lynch took it over to 14 billion when he left in 1990. Over this period, Lynch achieved a 29.2 percent average annual rate of return, which meant that a thousand dollars invested when Lynch started managing the fund in 1977 would have grown to twenty-eight thousand dollars by the time he left in 1990. In this video, we're going to listen to Lynch describe how he finds stocks with 10x return potential and then examine how he used that framework to make one of the best investments of all time, Dunkin' Donuts.

But first, make sure to like this video and subscribe to the channel because it is my goal to make you a better investor by studying the world's greatest investors. Let's dive in. You look for companies that have something unique, like an example would be Toys R Us. When I first found that, you know, they only were in, they only had several stores. You said yourself they could, this concept could have two or three hundred stores.

Now, by nature, some of those companies might be very boring. Well, yeah, that's terrific. I look for that. Great companies that are boring are wonderful for me. I've done well in companies like Dunkin' Donuts. Well, kind of like that. They're very easy to understand. No one's going to invent a better donut somewhere at MIT. You don't have to worry about creating or analyzing a Dunkin' Donuts company.

Well, there's a company that upgraded their stores. It spent a lot of time on the quality of their product. They really spent a lot of time to have a china cup. Their cup was worth over a dollar instead of just having a piece of paper or a plastic cup. They said, "We want to deliver something very good to the consumer." They really worked on the quality of their coffee. You know, every 15 minutes they throw it away, and they cook it within three degrees of the right temperature. They really cared about that.

As for the annual report, no, you had to go visit them and talk to them. You could find it out. You'd say, "This is something that really makes sense." The nice thing about it is if somebody comes up with a good donut system, they really have a great concept. It's in the state of Washington, it's not going to affect Dunkin' Donuts if they're located in Virginia or if they're located in Massachusetts.

Now, how did you stumble on Legs? This is a product my wife said worked very good, and at that point in time, I did a little bit of research. I found out the average woman was in the supermarket about twice a week, and all the hosiery being sold in supermarkets was just junk. So here's a company that made a good product, put it into the supermarkets, put it into the drugstores, made it readily available. It was an incredible success. It was the most successful product of the 1970s after Pampers, but Pampers was part of a very big company called Procter & Gamble.

This is part of a relatively small company called Haynes, so the stock was a huge success. It was eventually bought out by Consolidated Foods, a company now called Sara Lee. If it wasn't bought out, I think it, you know, would have been a hundred bagger instead of just a ten bagger. It was a big success at what point do you decide in a company to cut your losses?

It's only if the company's doing poorly. If you bought a company because you thought this new product was going to work, the aluminum industry was turning around and you know something about the aluminum industry. If all of a sudden the product isn't working or the industry is getting worse, if you're wrong in the fundamentals, then you sell. If the company's doing fine and the stock goes down, that's a great opportunity.

When you were actively managing money, you presumably are under the same pressures as other fund managers to show performance results. Did that incline you to sell too quickly sometimes? Well, I think my greatest mistakes are probably, you know, it's funny. In the stock, all you can lose is 100%. I've done that. Your great mistakes are selling a good company and then it doubles, then it triples and quadruples because you make a lot of mistakes since those ones that go up tenfold, like on the 10 baggers.

So some of my mistakes are saying, "Oh my God, this stock is too high," and I was wrong. You had to figure out what inning am I in this baseball game. I sold Toys R Us way too early. It went up 20 fold after I sold. I did the same thing at Home Depot. Those are probably two greatest mistakes I ever made.

When should you sell? Well, you ought to find out why you bought a stock. If you're saying it's a cyclical company and they're doing poorly and they're doing awful, you wait till things are getting better, and they're doing terrific, and then you sell it. But with a growth company, you have to say, "Walmart's case, 10 years after they went public, you could have bought the stock and made 500 times your money because they still are only in 15 percent of the United States."

And they could say, "Why can't they go to 17? Why can't they go 19? Why can't they go to 23?" So for the next four decades, then around the country. So you have to say to yourself, "In this stock, I have a 10-year story, a 20-year story. I'll be able to write that down and follow that." That's what I do with the company, and that's your decision. That's how you sell it.

They have a novel element from many investors today in the trust issue. Yes, we also have security problems that we didn't traditionally have in America. Have they changed the way you pick and believe in stocks? No, you still buy a company and you buy a company to grow. And if it's a textile company or it's an electronics company, a software company, you better understand what they do. And if they do well, the stock will do well no matter what happens in the market.

If the Dow Jones today was 1,000 or 500, you had made a lot of money in McDonald's. You would have made a lot of money in Johnson & Johnson. You want to make a lot of money in Gillette. These companies' earnings have gone up a lot the last 30 years, and if the market was 50,000, you would have lost money in Burlington Industries. I recommended that in 1969. I think it's gone from 34 to 2 with no stock splits. These earnings have been terrible.

Well, your modesty actually makes an important point, which is people with the best batting averages in the world don't bat a thousand. I sometimes get angry mail, particularly during bear markets, saying so-and-so recommended such-and-such and it went down. Well, how often did you come up with a clicker? Well, this is a funny business. You don't have to be right even five times out of ten. If the times you're right, you make a double and triple. It offsets all those times you lose twenty or thirty percent.

So when you buy, psychologize yourself. How much can I lose and how much can I make? And you ought to be able to make a lot. You see, stocks are risky. I mean, look at how much we lost on AT&T. Look how much less than Xerox. These were quality companies. You know, you could lose a lot in a stock. It's going to say to yourself, "How much can I make?" Because I want to buy a stock if I'm right. I'm going to make a double or triple.

Does your own confidence ever get shaken? Every day. I think the market's going to go up. You know, I keep calling a lot in my company, so I keep calling the company. So you can take advantage of the volatility market if you understand what you own. So I think that's the key element. Another key element is that you have plenty of time. People are in an unbelievable rush to buy a stock.

I'll give an example of a well-known company: Walmart went public in October of 1970. 1970, it went public and already had a great record. It had 15 years of performance, a great balance sheet. You could have waited 10 years saying you're a very conservative investor. You're not sure that Walmart can make it. You want to check your, you see them operating in small towns. You're afraid they can only make it in seven or eight states.

You want to wait, do they go to more states? You keep waiting. You could have bought Walmart 10 years after they went public and made 35 times your money. If you bought it when they went public, you would have made 500 times your money. But you can wait 10 years after Walmart went public and made, over 30 times your money. You could wait three years after Microsoft went public and made ten times your money.

Now, if you knew something about software—I know nothing about software—if you understood software, you would have said these guys have it. I don't care who's going to win: Compaq, IBM. I don't know who's going to win the Japanese computers. I know Microsoft, MS-DOS, is the right thing. You could buy Microsoft. Again, I'm repeating myself, stocks are not a lottery ticket. There's a company behind every stock, and you can just watch it. You have plenty of time. People are in an amazing rush to purchase the security. They're out of breath when they call up. You don't need to do this.

Now that we've heard Peter Lynch talk about how to find stocks with 10x growth potential, let's establish five criteria that investors can use to see if a stock passes the test for a potential 10 bagger according to Peter Lynch. First off, a company needs to have a unique product or service. This is what Warren Buffett describes as a moat. This may be the single most important thing to look for in a stock, but why is it so important?

A company with a strong competitive advantage is able to fight off competitors, charge more for its product or service, and ultimately be more profitable over a longer period of time. Take Apple, for example. The company has extremely loyal customers, and many people are obsessed with their products. This allows them to charge premium prices for their products and be by far the most profitable electronics company in the world. Apple's unique brand positioning makes it nearly impossible for a competitor to steal away Apple's loyal customer base.

The next criteria is to look for companies you can understand. This is the backbone of the investment philosophy Lynch lays out in his best-selling book, One Up on Wall Street. He is known for his famous quote, "Know what you own." He makes the argument that stocks aren't lottery tickets, but instead, they are pieces of businesses. Over time, the performance of your investment will depend on the underlying performance of the business. Truly understanding a business will give you an edge when you are assessing the long-term growth potential of a stock.

Third, look for companies that are underfollowed, meaning that they aren't already loved by the market and investors. If a stock is already highly followed and an investor favorite, it likely has increased in value substantially because of this. That means that if all the stock YouTubers are making videos about a particular stock, you should be cautious. Next up, and this one is an important lesson I learned from Peter Lynch: look for companies that are relatively small and have room to grow significantly.

While companies like Apple, Amazon, Netflix, Facebook, and Google all may be great companies and great investments, it is very unlikely that these stocks will 10x from the current price. That is simply because of the law of large numbers. Take Facebook stock, for example, which recently passed one trillion dollars in market cap. Assuming no share repurchases, the company would have to have a valuation of 10 trillion dollars in order for the stock to 10x.

With billions of people already with Facebook and Instagram accounts, there simply isn't enough room for the company to grow to 10x given its already large size. Now for the final point: don't sell too early. This point can be summed up with one of my favorite Peter Lynch quotes of all time: "Selling your winners and holding on to your losers is like cutting your flowers and watering your weeds." This is a mistake many investors—both new and experienced—make. They buy a stock that doubles, and they take profits and sell out of their position. At first, they are happy with the result.

However, as the stock continues to triple and quadruple, they quickly realize they sold too early. That's why it's best to follow Peter Lynch's advice to always hold a stock as long as the company is continuing to do well, even if it may seem tempting to take some profits.

Now that we've established the criteria for finding 10 baggers that Peter Lynch laid out, let's go one by one and see if these criteria apply to one of his best investments ever: Dunkin' Donuts. Dunkin' Donuts made Lynch 15 times his money—quite an impressive return for such a simple investment. As Lynch pointed out in the clip, despite the company selling rather ubiquitous products, coffee and donuts, Dunkin' Donuts had a relatively unique business model for a low-priced restaurant.

The company's focus on quality and providing a great experience for customers helped Dunkin' Donuts develop a loyal customer base who visit the store frequently, with somebody visiting every day as part of their daily routine. Additionally, once the company had entered a market and built up a customer base, it was difficult for a competitor to enter that same market and steal away customers.

On the second criteria, it is clear that Peter Lynch had a deep understanding of Dunkin' Donuts' business model. Listening to him talk in the clip about the company's business model, you would think he worked as an executive of the company. But it makes sense that Lynch had such a deep knowledge of the company considering that the company was founded in Massachusetts, just 30 minutes outside of where he lived and worked.

It is crucial to deeply understand a company before investing. This helps you avoid panic selling if the stock price falls. On the third point, Dunkin' Donuts was definitely an underfollowed stock at the time the company went public in 1968. This was during a period of time where the so-called Nifty 50 stocks were getting almost all the attention in the stock market. These Nifty 50 stocks consist of 50 stocks that were investors' favorites.

The 50 stocks identified represent some of the fastest-growing companies on the planet. In the latter half of the 1960s, their popularity amongst institutional and individual investors sparked a quantum shift from value investing to a growth-at-any-price mentality. While investors were focused on these stocks, companies like Dunkin' Donuts were able to remain underfollowed by investors despite the company's great growth prospects.

That leads us to our next point. At the time, Dunkin' Donuts was a fraction of the size it is today. The size of the potential market for Dunkin' Donuts was immense. Dunkin' Donuts could theoretically open a location in every town in America and on every street corner in the major cities. This doesn't even include international expansion opportunities. I mean, the company had huge room to grow from its relatively small size when the company IPO'd in 1968.

At the time, the company was mainly in select cities on the East Coast of the United States, but the company had plans to continue steadily expanding throughout the rest of the East Coast, Southeast, and Midwest of the United States. With Dunkin' Donuts clearly meeting all the other criteria, it is apparent that the company had the potential to be a 10 bagger.

However, the true potential of the investment wouldn't have been realized if Peter Lynch would have sold after the stock doubled or tripled. Because he was a true buy-and-hold investor and focused on the long term, Lynch held on to the stock. He truly understood the business and knew it was going to be a huge winner. So there we have it.

I hope you learned something from this video. Make sure to like this video and subscribe to the channel if you aren't already because it is my goal to make you a better investor by studying the world's greatest investors. See you next time.