Almost every investor in the world knows Warren Buffett. But, if you’re not as old as me, and don’t know Peter Lynch, he was one of the most famous and successful fund managers in the 1980s and early 1990s. 

As the manager of the Magellan Fund at Fidelity Investments between 1977 and 1990, Lynch averaged a 29.2% annual return. His returns were consistently more than double the S&P 500. The Magellan fund was the best-performing mutual fund in the world of its era.

Lynch quit the business on a high. His book, One Up on Wall Street is an investment classic.

Lynch had a unique insight. He said the average American investor could use knowledge gleaned from being a consumer to their advantage in the stock market.

The idea was that by identifying businesses and products that were popular on Main Street, you could get ahead of the curve and invest in the companies producing them, before their stocks became expensive and popular on Wall Street.

Lynch also introduced the term “bags” into the investment lexicon. A 3-bagger being a stock that tripled from the price you invested at, a 5-bagger being one that quintupled, and so on.

As a consumer, I often use Lynch’s strategy as a first research filter. Living here in Indonesia, with a young family, and local staff, our kitchen cabinet is fairly representative of what upwardly mobile urban middle class people are consuming, or aspiring to consume, in the food and beverage space.

ABC condiments and sauces (Heinz took over this excellent Indonesian business many years ago), snacks and biscuits from Mayora, instant noodles from Indofood, baby food from Kalbe Pharma, and so on.

Another example is Bata Shoes. I figured judging by the sheer number of pairs my daughter has bought that it must be a good business. Bata will likely be the topic of an in-depth research report for my paying readers in coming months. It is a big player here in Indonesia.

But I use this approach all over the world. A couple of years ago, after noticing that a type of four-colour pen I used to use at university nearly 30 years ago was still a popular seller, I ended up writing an investment research report on Bic – the French company that manufactures these pens.

One of my own success stories from using the Peter Lynch approach was an investment in San Miguel Brewery (no longer listed, as it was initially acquired by Kirin in a takeover, and then merged into San Miguel Food and Beverage and delisted at a later date).

San Miguel is the 400-pound gorilla in the Philippines beer market. The company sells about 95 out of every 100 beers consumed in the country. I consumed my fair share when I was living there, too!

In 2007, San Miguel Corporation spun off part of its brewing division as a separate “tracking stock.” Noticing that they were doing very well with their low-carb beer, San Miguel Light, and knowing the company was so dominant, I was surprised the valuation on the stock was not higher. So, I bought some shares in 2008, during the financial crisis, for under 8 pesos, as I recall.

It wasn’t too much longer before the company got a takeover offer from Kirin of Japan, at 8.841 pesos per share, in 2009. Rather than accept the takeover and take a modest 10% profit, I bought more shares on market, and kept them.

I knew from prior experience that there is no such thing as “compulsory acquisition laws” in The Philippines. (In many countries, once a bidder has got to a 90% threshold, they can force the hold-out shareholders to sell to them). And I didn’t want to sell, as I felt Kirin was buying the company too cheaply.

Sure enough, in mid-2010 I was on my way back to Manila from Zurich, flying Thai Airways. Upon checking my brokerage account during the stopover in Bangkok, I saw San Miguel Brewery shares had rocketed to more than P15.  I sold them for double my initial entry price not long after.

However, they then nearly doubled again, last trading at P29.30 on December 28, 2012. Eventually, the 0.61% of the company’s shares that were still listed on the stock exchange were delisted, in a tender offer at P20 per share. The company was merged into a new listing called San Miguel Food & Beverage (FB on the PSE).

There’s more than one lesson in that story, involving the opportunities available in “spin offs,” and “takeovers,” and the importance of not selling winners too soon. But, the point for the purposes of this article is that you can sometimes get profitable investment ideas by looking at the companies behind the products and services you use in your everyday life.

But finding a listed company with a wildly popular product or service is not enough. You then have to do the Warren Buffett-style analysis to see if the management of the company is both ethical and competent, whether the company’s business is shielded from excessive competition (that is, has a “moat” around it), and whether its market prospects mean it can reinvest a meaningful portion of its earnings each year to keep compounding its growth over a significant period of time. You should also make sure the company does not require excessive debt to run its business.

If all the factors align, the final step of course is to check if the stock is cheap enough. If not, put it on your watch list. Then wait.

How cheap is “cheap enough” will depend on your own investment goals. If you are looking to grow your money at 10% per annum, you will be looking to pay no more than $1 of book value per 10c of earnings that the company delivers each year.

So, for example, if the book value, which is all the assets minus all liabilities for the company, comes to $100 million, and the annual earnings the company delivers come to $20 million. Then you can afford to pay up to $200 million for the entire company. So, if there are 10 million shares outstanding you could pay up to $20 per share.

This is obviously a simplified calculation. But the key take-way is this: To make big returns from the stock market, you not only need to buy the right businesses, you need to underpay for them.

As I’ve said elsewhere, a good company can be a bad investment at too high a price. And while I prefer to avoid mediocre companies, they can also be good investments if you purchase their shares cheaply enough.