The Ten Bagger Principle

Currently I am reading "Beating the Street" by Peter Lynch and John Rothchild. I've finished "One Up on Wall Street". Most investors here would be able to identify with Peter Lynch's investing philosophy for one reason: he encourages an all equity portfolio.

For a background on Peter Lynch, please refer to this link.

The first thing I would like to address is the idea of a bagger. A two bagger will be a stock that multiplies twice, while a ten bagger would be a stock that multiplies itself ten times. It's derived from baseball, although bowling has the same name for the number of strikes you get after a turkey.

Peter Lynch is a strong advocate of the buy and hold strategy, and he has stated that 2 points

1. If an investor goes by the philosophy that he will sell if the stock goes up 50%, he will never be able to obtain a bagger. Likewise if you go by the philosophy of selling the stock when it is a two bagger,you will never be able to obtain a ten bagger.
2. Show him a portfolio with a stop loss of 10%, and he will be able to show you a portfolio that loses 10%.

In light of the financial crisis, the wisdom of the buy and hold strategy has been repeatedly questioned and more mutual fund managers are becoming flexible and not holding as long as they used to.

I personally feel that taking profit is never a bad thing, and buying low and selling high is an excellent strategy (I mean who wouldn't, that's the essential of making money). The question comes is how to time the market. Maybe there are few beings out there with superior ability as compared to most of us investors that are able to tell when is the bottom and the top. And the list of investors that will be able to do that wouldn't have my name on it.

Buying and holding undervalued companies would instead provide a return that wipes out market irrationality and rides through economic boom and bust. The fact is that many of us are unable to time the market. Further evidence can be found here. Finding companies that are undervalued will provide us with the margin of safety for investment, minimizing possible downside and increasing possible upside.

I believe that should there be no external influences such as a requirement for money, selling should only occur if there is a(n) (anticipated) change in the fundamentals of the company or macroeconomic conditions, or that you require to reposition your portfolio. I would like to emphasize that stock picking is important, and sitting on for the ride is extremely important.

I leave everyone with an idea that Peter Lynch was putting across.

If I had 10k, and I invested 1k in 10 companies. If one of the undervalued companies produces a 10x returns, essentially the other 9 companies can be declared bankrupt and I did not make any losses. This is the effect of the ten bagger.