“Never invest in any idea you can’t illustrate with a crayon.”
– Peter Lynch
Peter Lynch is one of the greatest investors of all time. He became famous while running Fidelity’s Magellan Fund from 1977–1990.
During his time at the helm, he averaged an astonishing 29.2% annualized return. To put this into perspective, the average annual return for the S&P 500 is around 10%. So yeah, he nearly tripled the market’s performance over a 13-year timeframe.
That’s “G.O.A.T.” status if you ask me.
The quote above is one of my favorites. It resonates with my own philosophy on investing. But it took me years to learn the importance of focusing on simple investment ideas.
Whether you’re an experienced investor or just a beginner, it’s a valuable lesson that will help you appreciate great businesses… and avoid many of the worst stocks.
Businesses you can illustrate with a crayon
When I first started investing, I thought complicated equaled good. I bought stocks based on hype about how a company was “going to change the world” with some complex, new technology.
As a beginning investor, I didn’t know any better. But after losing money repeatedly, I began to question the validity of hard-to-understand stocks. Instead, I began focusing on companies that were easy to comprehend.
Basically—similar to Lynch’s idea of illustrating an idea with a crayon—if I couldn’t explain what a company did to my mom… I passed on the stock.
I began to focus on businesses that made great products and had solid fundamentals, like growing sales and earnings. I even studied some of the best-performing stocks of all time. To my amazement, most of them were quite easy to understand… like Coca-Cola and McDonald’s, for example.
And there are plenty more recent examples to consider, like Starbucks (SBUX): Making and selling coffee is a simple, straightforward business that anyone can understand.
Of course, it helps that people are obsessed with those $5 lattes… myself included.
Not surprisingly, the stock has been an absolute stud since the company went public in 1992. And it’s been a monster Big Money magnet—continuing to garner support from institutional investors over the past decade. Have a look:
First, notice all the blue bars. Those are days when the stock ramped in price on big trading volume. That tells us institutional investors were buying. Then, see how the chart is going up over time… which means there’s a solid uptrend for us to ride.
I grabbed shares myself years ago based on the simplicity of Starbucks’ business. And I’m glad I did.
Another example is Visa (V). Visa doesn’t issue credit cards or worry about extending credit to people… instead, it focuses on running the network that lets folks use their cards. I like to think of the business as a tollbooth… it collects a small fee each time a card is swiped.
Today, it operates a massive payment network in over 200 countries around the world… and accounts for about half of the total purchase volume on credit cards. Last year, the company raked in nearly $22 billion in revenue… and kept almost half of that number as profits ($10.9 billion).
Let’s take a look at Visa’s long-term chart:
Again, those blue bars are Big Money buy signals… and the more, the better. That’s the stairway to heaven, baby.
I bought shares of Visa in 2017 and as you can see, the stock has continued its steady rise.
Starbucks and Visa exemplify Peter Lynch’s preference for simple businesses. Both have become massive, worldwide enterprises with thousands of employees. But at their core, they’re both easy-to-understand businesses that can be illustrated with a crayon.
Avoid these complex stocks
Every industry has its share of complex, overhyped players.
But the easiest example of a bad investment is specialty purpose acquisition companies (SPACs). In short, SPACs are “shell companies” that raise money from investors in order to purchase a private company.
It’s a way for a private company to go public while avoiding the traditional IPO route.
I traded SPACs during my career on Wall Street. We referred to them as “blank check companies.” That’s because the idea of a SPAC is investors entrust their money with sponsors—the SPAC’s management team—looking to acquire an early-stage business.
Try explaining that with a crayon. SPACs are difficult to understand… and their fee structures are often complex.
But an even bigger reason to stay away from SPACs is their historical performance. A study released by Renaissance Capital last year revealed that since the start of 2015, only about 30% of SPACs completed a merger or took a company public. In other words, about 70% of SPACs never followed through with their acquisition plan, which means the IPO proceeds were liquidated and shareholders received their pro rata amount.
Of the 30% that completed their goal, their shares had an average loss of 9.6% and a median return of -29.1%. These results are especially terrible considering the average aftermarket return is 47.1% for traditional IPOs since 2015.
As you can see, these complicated investment vehicles are trouble for investors. They’re a perfect example of the kind of complexity you should avoid.
Here’s the bottom line: We can learn a lot from the great investors of the past. Peter Lynch said to never invest in any idea you can’t illustrate with a crayon. And I agree: Many of the best-performing stocks are easy to understand, like Starbucks and Visa.
If you don’t understand a business… you should be skeptical. SPACs left a sour taste in my mouth years ago. I’ve stayed away from them ever since. And the historical data shows they tend to underperform the rest of the stock market.
Peter Lynch has plenty of other amazing quotes. Check out this Lessons With Luke video, where I go over my top 10 favorite Peter Lynch quotes.
P.S. When it comes to investing, simple is better… And it’s the central philosophy behind The Big Money Report: We buy companies with great businesses… growing profits… and that are Big Money magnets.
This strategy made me wealthy enough to retire from Wall Street at 31 years old… And it can help you do the same.