Peter Lynch is the guy who managed the Fidelity Magellan Fund and grew it from $20 million to $14 billion from 1977 to 1990. He believes in using what you know to find stocks. You have first-hand knowledge in the industry you work in, so you probably understand your industry better than some analysts. He also believes in categorizing your stocks, so that you know what type of stock you’re investing in.
Lesson 1: use your knowledge
If you work in the technology industry, you might have heard of Avigilon Corp. (TSX:AVO), the fast-growing company that creates end-to-end security solutions. Your friend in the same industry might have let you know that the company is hiring new talent in multiple locations. A company that’s hiring is one indicator that it may be growing.
There’s nothing wrong with buying big companies such as Toronto-Dominion Bank (TSX:TD)(NYSE:TD) that you know are doing well, but you might discover tenbaggers by using the knowledge that’s unique to you.
I’m not implying that Avigilon is a tenbagger, but it should have higher growth than bigger companies since Avigilon is a small cap with a market cap under $537 million, and its target market could grow from $18.5 billion in 2014 to $28.4 billion in 2018.
Lesson 2: categorize your stocks
It’s important to categorize your stocks, so you have a better idea of what to expect from them. Avigilon would likely be categorized as a growth stock. However, with the recent slow growth, investors are wondering whether that growth will continue and, as a result, its multiple has contracted. If you believe growth will resume, then you’d buy the stock.
On the other hand, Toronto-Dominion Bank is a steady dividend-growth company that is expected to grow 5-8% a year. Throwing in the 3.8% dividend, investors can expect total returns of roughly 8.8-11.8% per year.
Investors would buy the two companies for very different reasons. You would buy Avigilon for potential growth, and Toronto-Dominion Bank for its growing dividend and steady growth. By categorizing the companies you buy, you’ll have an easier time holding on to companies when there’s a down market.
Companies can move from one category to another as well. For example, a turnaround stock like General Motors Company can quickly turn into a fast grower if demand for its vehicles picks up.
Don’t be afraid to use your knowledge to find companies that could be potential investments. Categorize your stocks, so you’ll have the right expectations for the kind of returns they give. If you prefer dividend stocks because you want a steady income, so be it. That’s the fun of investing. You can choose what you want and what you don’t want to invest in.
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Fool contributor Kay Ng owns shares of Avigilon and The Toronto-Dominion Bank (USA). Avigilon is a recommendation of Stock Advisor Canada.