Why Lynch’s Advice to Buy What We Know Still Applies Today…

Peter Lynch is a name from the past many investors still recognize today.

Lynch managed the Fidelity Magellan Fund from 1977 to 1990, growing it into the largest fund in the world at that time. By the time Lynch retired, the fund’s assets had swelled to $14 billion from just $20 million when he had started.

The fund’s performance is what attracted investors to it. Lynch delivered an average annual return of 29% and consistently outperformed the S&P 500. With a return rate like that, investors would more than double their money every three years.

I mean, it is no wonder Lynch was able to grow Magellan so quickly.

I like to study the great investors and learn how they beat the markets. Lynch has provided us with a roadmap of how he thinks about the markets in his books “One Up On Wall Street” and “Beating the Street.” As you can tell from the titles, Lynch believed individual investors could outperform professional investment managers.

He advised individual investors to “buy what you know.” By that he means you should be able to explain what a company does if you’re investing in it. Even though Lynch’s advice makes great sense, not all investors follow this advice.

I know for a fact that tech investors sometimes have a hard time explaining what the companies they invest in do, but yet they still decide to invest in them. Lynch would have warned against this.

One way to buy what you know, for example, is to look for investment ideas when you go shopping. Stores you like at your local mall could be good investments under Lynch’s philosophy because it is likely other consumers might also like the same ones. As he explained, “If you stay half-alert, you can pick the spectacular performers right from your place of business or out of the neighborhood shopping mall, and long before Wall Street discovers them.”

Buying a stock just because you like the company’s products won’t necessarily generate market-beating investment results. It is also important to analyze the financials and be sure the stock is a good buy.

I regularly do this by looking at the company’s latest earnings report.

But another way to buy what we know is by buying brands. Companies understand this, which is why they emphasize brands on their products and in their marketing. It is the brands that add value to the company after all.

Procter & Gamble (PG), for example, has brands that include Crest, Pampers, Vicks, Tide and Swifter. These brands sell at a premium to generic items that are, in many cases, just as good. I personally know a number of moms who would never buy generic toothpaste even though it contains the exact same amount of fluoride and probably tastes the same as name brand products. We want Crest for our kids, just like our moms wanted for us. The value of the brand lies in the premium pricing.

With its 65 different brands, P&G reported revenue for the 12 months ending in March, 31, 2022 of roughly $79.6 billion — that’s a 6.34% year-over-year increase. So when we think about P&G, we understand that its brands provide value to the company.

This week’s pick in PepsiCo Inc. (PEP) is also known for its strong brand recognition and follows Lynch’s advice to buy what we know.

Pepsico is a food and beverage company that has successfully manufactured, distributed and marketed its products to customers for over a century now.

It is home to many products we’ve bought and loved our entire lives, like Mountain Dew, Sierra Mist, Propel, Gatorade, Tropicana, Quaker Oats, Cheetos and so many others. In fact, Pepsi also makes and markets some of the best ready-to-drink iced teas and coffees for Lipton and Starbucks.

Despite consumers having to pay more for its products due to high inflation levels, Pepsi still reported strong first-quarter earnings and revenue this past April that beat Wall Street’s expectations.

The beverage and snack giant reported a net income of $4.26 billion, or $3.06 per share, up from $1.71 billion the previous year. Pepsi posted a core earnings of $1.29 per share, with revenue rising more than 9% to $16.2 billion.

The company also announced a $193 million impairment charge, after taxes, as it attempts to suspend some of its juice brands in Russia in response to the country’s invasion of Ukraine. Pepsi makes about 4% of its annual revenue in Russia, one of the only countries where it has a larger presence than competitor Coca-Cola Co. (KO).

Pepsi did reveal that it will continue to sell essential products like baby formula and food in Russia.

The news, however, didn’t have much of an impact on the company’s stock. Pepsi hit a brand-new 52-week high of $177.62 just two days after it released Q1 earnings on Tuesday, April 26.

If you’re one of my sharp-eyed readers (and there are many of you here), then you’ve probably noticed by now that I often recommend selling puts on stocks that are trading near new 52-week highs…

But, of course, it also helps that Pepsi is on an Income Trader Volatility (ITV) “buy” signal, which means now is one of the best times to take advantage of it.

To minimize our risks, I’m recommending a trade that is protected by strong technical support and will be open for roughly four weeks.

Options writing is a great income strategy, but the best returns will require finding the best individual trading opportunities at any given time. The upside will always be capped with options writing, but will often be greater than 3% if the right options are selected.

Consider writing options as an income strategy, but use individual stocks and write individual options rather than buying a covered call ETF to maximize potential gains.

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