Below are the key lessons I took from the book. Keep in mind these are the lessons I found relevant to me personally. There is a lot covered in the book that I haven't mentioned below, maybe because it's something I've already internalised and didn't need reminding of, or something that I just didn't find interesting or important. However, they might be interesting or important to you. Therefore, I still recommend you read the book fully so you don't miss anything!

The Smart Money Is Not That Smart

People always think because a professional fund manager picked a stock that it's probably a good stock.

The truth is 90% of fund managers underperform the market, meaning the opposite is true. If a fund manager picks something, statistically you are better off not to pick that stock.

In fact, the amateur investor has many built-in advantages that the professional investor doesn't.

The professionals are simply not allowed to invest in stocks that are too small, too risky, or not approved by their employers.

For example, because of regulations, big funds can't invest in small companies, because the disclosure requirements are too cumbersome. They are often given a mandate to only invest in large companies, because even though the returns might not be as good, they're less risky - "No fund manager gets in trouble for losing the client's money in IBM. The client will simply ask, what's wrong with IBM? But if you lose their money in a risky small cap, they will ask, what's wrong with you?"

 This means the reason if you're buying a stock that no professional is buying, the reason might simply be they're not allowed to buy it (even if they think it's a winner).

It doesn't take much to outsmart the smart money, which is often not that smart, and the dumb money isn't always as dumb as it thinks.

Street Lag

Street lag refers to Wall Street's tendency to "lag" when noticing a high performing stock.

Many small companies can grow 50x or 100x before Wall Street even hears about.

Again, this is because the companies are either too small or obscure, or they're not in "sexy" industries.

Lynch goes through four or five examples of stocks that gave tremendous returns and even after going up 10x or 20x, there were still only 1 or 2 analysts covering it.

Compare that to the fifty-six brokerages that would be covering IBM or the forty-four covering Exxon Mobil.

In fact, Wall Street often looks for reasons not to buy these stocks, so they can give an excuse to their clients when they miss out on the gains.

"It was too small."

"It had no track record."

"It was in a non-growth industry."

"Unproven management team."

"The employees were all unionised."

"Too much competition."

Stocks Outperform Bonds

In spite of crashes, depressions, wars, recessions, stocks in general have paid fifteen times as well as corporate bonds and thirty times better than Treasuries since 1929.

In short - if you're investing for the long term, stocks beats bonds every time.

The Stock Market Is Irrelevant

You should never be investing based on the sentiment of the market.

Whether the market is going up or down is irrelevant.

You should be investing in companies, not the market.

If you find a company selling at a bargain price, with good earnings and good management and it ticks all the boxes for what you require in a successful company, then you should consider it a good investment no matter what the market is doing.

The reason is, we can never guess or be prepared for what the market does.

"The day after the market crashed on October 19, people began to worry that the market was going to crash.

It had already crashed and we’d survived it (in spite of our not having predicted it), and now we were petrified there’d be a replay.

Those who got out of the market to ensure that they wouldn’t be fooled the next time as they had been the last time were fooled again as the market went up.

The great joke is that the next time is never like the last time, and yet we can’t help readying ourselves for it anyway. This all reminds me of the Mayan conception of the universe.

In Mayan mythology the universe was destroyed four times, and every time the Mayans learned a sad lesson and vowed to be better protected—but it was always for the previous menace.

First there was a flood, and the survivors remembered it and moved to higher ground into the woods, built dikes and retaining walls, and put their houses in the trees.

Their efforts went for naught because the next time around the world was destroyed by fire.

After that, the survivors of the fire came down out of the trees and ran as far away from woods as possible. They built new houses out of stone, particularly along a craggy fissure. 

Soon enough, the world was destroyed by an earthquake.

I don’t remember the fourth bad thing that happened—maybe a recession—but whatever it was, the Mayans were going to miss it. They were too busy building shelters for the next earthquake."

Warren Buffett says - "As far as I'm concerned, there is no stock market. It is there only as a reference to see if anybody is offering to do anything foolish."

The Cocktail Theory

"If professional economists can’t predict economies and professional forecasters can’t predict markets, then what chance does the amateur investor have?

You know the answer already, which brings me to my own “cocktail party” theory of market forecasting, developed over years of standing in the middle of living rooms, near punch bowls, listening to what the nearest ten people said about stocks.

In the first stage of an upward market—one that has been down awhile and that nobody expects to rise again—people aren’t talking about stocks. In fact, if they lumber up to ask me what I do for a living, and I answer, “I manage an equity mutual fund,” they nod politely and wander away.

If they don’t wander away, then they quickly change the subject to the Celtics game, the upcoming elections, or the weather. Soon they are talking to a nearby dentist about plaque.

When ten people would rather talk to a dentist about plaque than to the manager of an equity mutual fund about stocks, it’s likely that the market is about to turn up.

In stage two, after I’ve confessed what I do for a living, the new acquaintances linger a bit longer—perhaps long enough to tell me how risky the stock market is—before they move over to talk to the dentist.

The cocktail party talk is still more about plaque than about stocks. The market’s up 15 percent from stage one, but few are paying attention.

In stage three, with the market up 30 percent from stage one, a crowd of interested parties ignores the dentist and circles around me all evening.

A succession of enthusiastic individuals takes me aside to ask what stocks they should buy.

Even the dentist is asking me what stocks he should buy.

Everybody at the party has put money into one issue or another, and they’re all discussing what’s happened.

In stage four, once again they’re crowded around me—but this time it’s to tell me what stocks I should buy.

Even the dentist has three or four tips, and in the next few days I look up his recommendations in the newspaper and they’ve all gone up.

When the neighbors tell me what to buy and then I wish I had taken their advice, it’s a sure sign that the market has reached a top and is due for a tumble."

Every Day Is Stock Research

You have a huge advantage of institutional investors, because you see products and services before them, and can be introduced to local companies far before Wall Street.

Every time you go to the shopping mall, eat at a restaurant or receive a gift you are doing stock research. The long lines at a new clothing store or the popularity of some new gadget among your friends is the best kind of stock research there is (because analysts from big investment banks will be doing "research trips" to the same stores and malls, only five years later down the track!)

Especially when you go to work - you will be exposed to thousands of different investment opportunities. For example, you might see a new courier company delivering your packages, a new software being used by your team etc. These are all tips for you to think "That product or service might become big - let me check it out."

Some of your highest returning investments will be discovered this way.

Small Companies, Big Gains

The biggest potential gains are made in small companies.

If a company is worth $10m, it's feasible for its profits to double, triple, or even go up by 10x or 500x.

Big companies simply cannot grow fast because they're already too big. Coca Cola has a $300b market cap. If it were able to double its sales every year, it would very soon be bigger than the entire US economy.

Large caps can be good defensive picks, but don't expect big gains from them, even if you buy them at a good price.

Six Categories Of Stocks

• Slow Growers
• Medium growers (stalwarts)
• Fast growers
• Cyclicals
• Turnarounds
• Asset plays

Slow growers

Slow growers are expected to grow slightly more than the economy. Usually these are fast growers that have slowed down due to size, industry growth slowing down, or a change to a more conservative style of operation.

Every fast growing industry eventually becomes slow growing. Railroads were a fast growing industry, then it was cars (Ford, GM), then it was steel, then it was computers (IBM, Dell). 

Slow growers generally have flat charts and pay a stable dividend.

Generally slow growers aren't useful in a portfolio, because you can just invest in the index for less risk.

Things to look out for: Look for dividends that are routinely raised. If the dividend payout ratio is low (dividends as a percentage of earnings), that's good, it means they have a cushion in hard times.

When to sell: You've gained 50%. The company has lost market share for two consecutive years. Now new products are being developed. It's diworseifying. It has a deteriorating balance sheet.

Stalwarts

These are medium growers - companies like Coca Cola, Colgate, Hersheys etc. 

The charts of these companies are not flat, and still trend upwards, but you might only expect 10% earnings growth (if that).

If you buy these companies at the right price, you can make a sizeable profit.

It's very unusual to get a ten bagger from a stalwart.

Stalwarts are best used as defensive purchases during a downturn, and you can sell when you return 1x or 2x of your money. If you're a defensive investor, it can be good to have a few stalwarts in your portfolio to anchor it and help you sleep at night, while still offering growth potential.

Things to look out for: Make sure you don't pay too high a price. Check for possible diworseifications and avoid if so. See how the company fared during previous recessions. Only buy if they have some growth potential.

When to sell: Its PE has become expensive compared to peers. New products aren't doing well. No insiders have bought in the last year. Growth rate slowing. Good idea to sell and replace with another stalwart if you already have made a gain.

Fast growers

Small, aggressive enterprises that grow at 20 to 25 percent per year. This is where 10 to 100 baggers are found.

Remember - fast growing companies can still exist in slow growing industries - such as a beer company who has an interesting new product and takes market share from the stalwarts. Marriott was a very fast growing company in a slow industry (hotels).

Of course, fast growers have higher risk. Look for ones that are profitable and have strong balance sheets.

Things to look out for: Is it growing too fast? 25% seems to be the sweet spot. Any faster than that and it could be overhyped. Ensure the company has validated the idea in multiple geographies. Find a stock that hardly any institutions own.

When to sell: Same store sales are down. New stores are disappointing. Top executives are joining rival firms. The stock is selling at high PE, and earnings growth is low in comparison.

Cyclicals

Cyclicals profits rise and fall in a predictable and regular fashion.

Things like tourism, or industries that depend on the weather can be cyclical, or even luxury goods.

When the economy is coming out of a recession, cyclicals often flourish, as spending rises rapidly, and vice versa.

If you buy cyclicals at the top of the cycle, you can lose a large amount of capital, and it may be years before the next upswing.

Cyclicals often deceive people because they are well known companies and amateur investors think their profits are "safe". They may be safe, but the stock price will go through peaks and troughs which means you risk large paper losses if you buy at the wrong time.

It's important to get involved in cyclicals when you have some sort of edge or knowledge of the industry.

Things to look out for: Keep a close eye on inventories. Watch new entrants into the market. Only invest if you understand the cycles.

When to sell: When inventories are building up. Falling commodity prices. The company is trying to cut costs but can't compete with foreign competitors. Capital spending requirements have gone up.

Turnarounds

These are companies that have been battered down and are performing poorly, but you think there's a catalyst that may make them turn around.

A poorly managed cyclical can be a good candidate for a company that has been depressed and may turn around with the right management.

If a company is too big to fail, and is likely to get government bailouts, that can be a potential turnaround.

Companies dealing with black swan events or one-off disasters can also be good turnarounds.

Things to look out for: Can a company survive a raid by creditors? How much cash/debt do they have? How will they turnaround? Is there a clear strategy? Are costs being cut? Is the business coming back?

When to sell: After it has turned around (when the "trouble" is over, shareholders aren't embarrassed to own it, and it's become what it was before - a stalwart, cyclical etc.

Asset Plays

An asset play is any company that has "hidden" assets - i.e. maybe the company has assets of $100 per share, but the stock price is only $20 per share.

Alico, a small farm in Florida was selling for $20 per share, but upon visiting the company, you would have seen just the land the farm was on was worth $100 per share. 

Asset plays require some working knowledge of the company and industry, but most of all they require patience. It can take some time for the market to realise the true asset value.

Companies don't stay in the same category. For example, fast growers turn into stalwarts. Turnarounds get turned around and then turn into cyclicals. Any company can regress into a turnaround. If it regresses too far, it can be come an asset play.

Also, some companies can be two categories at once - a fast growing cyclical, or a stalwart asset play.

When to sell: When its asset value has been discovered. If asset sales are not fetching their market value.

Each Stock Has Its Own Strategy

It is folly to run your portfolio on hard rules like "sell when you double your money" or "sell if it falls ten percent".

This is because no generic formula can ever apply to all stocks, or even all stocks within a category.

There's no point selling a fast grower when you double your money, because you could miss out on 100x'ing your money. However, selling a stalwart after you double your money might make sense.

Focus On Simple Stocks

If somebody says, "any idiot could run this business" that is a plus.

Complicated businesses are just more risky and harder to understand the numbers.

Donut shops and tire companies are much easier to make good investment decisions for than fiber optics companies or electric car companies in China.

Some characteristics of good simple companies:

It sounds dull, or even ridiculous. 

The truth is - companies with stupid names are often undervalued. A stock like Automatic Data Processors is a much better place to look for value than a stock named Tesla, or Spotify.

Everyone is looking at the latter, sexy stocks. Nobody is looking at Bob Evan Farming or Automatic Data Processors. Who wants to put their life savings into Bob Evans Farming? Brokers will recommend it to clients and they'll say no just because it sounds boring. 

The reality is, a dull name might help you get a stock as much as 50% more undervalued than if it had a sexy name. 

It has a dull business

Dull businesses are fantastic value opportunities. If a company makes paper, or bottle caps, or coffins, nobody bothers to look at it until its gone from $10 to $150 and everyone realises it was undervalued. They would've known if they'd taken the time to look, but who wants to read an annual report about bottle caps?

A dull business is great, but a dull business with a dull sounding name? That's the best business of all.

It has a disagreeable business

A boring company with a boring name, that does a business that is gross or unpopular is the best. Funeral homes, waste management etc.

Spinoffs

Spinoffs normally have strong balance sheets, as it looks very bad on the parent if the spinoff goes bankrupt. 

Since spinoffs normally have poor literature and reports sent out before the spinoff, and are ignored by Wall Street to a large degree, they can be a great place to find value.

Also, new shareholders often dump their newly issued stock in the spinoff, which can lead to it being oversold.

Institutions don't own it and analysts don't follow it

Stocks with little to no institutional ownership are always potential winners.

Low growth industry

While most attention is given to high growth industries, low growth industries like knives and forks and funerals are where the hidden gems are found.

While everyone is watching which microchip is going to be the best and which new smartphone is going to have a built in drone there are companies making billions of dollars on all the boring things we've forgotten about, like cups and chairs.

It has a niche

If you're in a movie or jewellery business, you're competing with every jewellery business in town and every movie business in the world.

If you own a quarry, you're not competing with anyone.

The rival quarry from two towns away isn't going to haul his rock into town and try and compete with you, because he'll lose. No matter how good the rocks are, nobody's going to pay the extra cost of shipping thousand of kilos of rock. It would make more sense for him to just focus on selling rock in his own town. This means quarries have a monopoly on the market, and they don't need to pay a lawyer or file a hundred patents to protect it.

Insiders are buying

The best tip-off you can get is if insiders are buying the stock.

When insiders are buying you can be certain the company isn't going bankrupt in the next six months.

When insiders are buying, I'd bet there aren't three companies in history that went bankrupt in the near term.

Insider selling, on the other hand, isn't the same. It doesn't always mean something bad if an insider is selling. Maybe they just need to pay the mortgage, or have a child in hospital.

But when an insider buys, there is only ever one possible explanation. They believe the stock price is about to go up.

The company is buying back stock

Buying back stock is a large vote of confidence to the company's strong cashflow and that the stock is undervalued.

Avoid Stocks With Good Publicity

Carpets was the hottest industry. Every housewife wanted carpets wall to wall in their home.

Wood floors were once cheaper than carpets, but the industry developed and carpets became cheaper, so the upper classes switched from carpet to wood, but the masses shifted from wood to carpet.

Carpet sales rose dramatically and carpet companies were earning more than they knew what to do with.

That's when analysts started telling brokers and clients that the carpet boom was unstoppable and would last forever. And at the same time, a hundred new carpet companies started up, all competed against each other and none of them made any money.

Another stock you should avoid in the same vain is the "next something".

The "next Amazon" or the "next McDonald's" never turns out to be anything like Amazon or McDonalds.

Avoid Diworseification

Instead of buying back shares or paying out dividends, some companies think they should grow by acquisition.

Diversification is okay. But diworseification is when a company makes an acquisition that

- Overpriced

- Outside their expertise

This usually leads to a string of diworseifications in the bull economy, and then a string of selling them all at big losses in the downturn.

A good example is Gillette, who had a bulletproof shaver and razor blade business, but diversified into medication, digital watches, then eventually sold them all with big write-offs. 

If a company is making acquisitions, there needs to be some kind of synergy between the two businesses. If not, it's likely diworseification and the share price will suffer.

Your Investment Should Have A "Story"

Once you've identified a stock that's promising, you need to learn as much as you can about the stock's prospects.

What is the company doing to maintain or grow its current sales and profits? What catalysts can you see that will provide growth in the future?

Peter Lynch calls this the "story", in finance terms, it's known as the "thesis".

With the exception of an asset play, where you can sit on your hands and wait for the market to catch up to the asset price, every stock must have some kind of event that needs to happen to keep earnings moving.

You should be able to give yourself a two minute monologue on why the stock has a compelling story in a way that even a five year old could understand, then you have a sound understanding of the stock.

If it's a slow grower, the key to the story will be some catalyst for growth and a strong dividend.

If it's a cyclical, the story requires changing business conditions and prices and something that will catalyse the uptick in the cycle.

For an asset play - company needs to be at no risk of bankruptcy and assets should be worth more than the market cap.

Turnarounds - Must be some catalyst showing that the business can reverse its fortunes - new CEO, change of strategy etc.

Stalwarts - a lower than usual PE ratio, and/or something that might accelerate the growth rate, and/or if the price is depressed for no reason.

Fast grower - how and why can it continue to grow fast?

Real world research is the best research

Wandering around stores and talking to customers in real life is one of the most effective forms of stock research.

In Toys R Us, look at how much people spend, ask them how often they come. If you see someone driving a Tesla, wander over and ask what they think of it, and if they'd recommend it.

Society is so sheep-like nowadays that it's reasonable to assume what's popular in one shopping mall is going to be popular in all shopping malls.

Recheck The Story

You need to recheck the story every few months.

This means reading the quarterly reports, all the company announcements, and listening in on earning calls. It also means keeping up on real world research, like checking the stores regularly at the mall.

If the company is growing its store count by 50 every year, eventually it's going to saturate all its possible locations, and the story will change. That doesn't mean it can't still grow. For example - McDonald's was in every city in America, but it still managed to grow with new innovations like McDonalds Breakfast and Drive Thru. It's up to you to stay updated on the story.

It's better to miss the first move

You don't need to get in super super early. It's wiser to miss the first big move, while you wait to see if the company's plans actually work out. You can still get in early after that, and you might miss the "mega" gains, but you will reduce a huge amount of risk.

Aim for 12% plus

If you're picking stocks, you should outperform the market for it to be worthwhile.

If you can get around 10% just buying the index without any homework at all, then 12% to 15% or more should be the minimum to compensate you for all the research, investigating, reading, subscriptions to tools and magazines etc.

Spread your bets

Spread your bets among each of the categories - stalwarts, turnarounds, asset plays etc.

Remember - the key is knowledgeable buying. Buy stocks you understand, varying across categories.

Buy when it's down!

A price drop in a good stock is only a tragedy if you sell it instead of buying more. 

If you've researched the company and believe it to be a good investment, a price drop is an opportunity to load up on a bargain. If you can't convince yourself "When I'm down 25%, I'm a buyer" instead of "When I'm down 25%, I'm a seller" then you'll never make a decent profit in stocks.