Legendary investor Peter Lynch shares the 2 things investors should look for when picking stocks

• Legendary investor Peter Lynch has a long track record when it comes to picking individual stocks. 

• He generated big returns when he managed Fidelity’s Magellan fund and popularized investing in what you know.

• Here are the two things investors should look for when picking stocks, and one trap to avoid, according to Lynch.

Legendary investor Peter Lynch, who grew Fidelity’s Magellan fund assets under management from just $20 million in 1977 to $14 billion when he retired in 1990, offered investors advice when it comes to picking individual stocks.

He popularized the idea of investing in what you’re familiar with in his 1989 book “One Up On Wall Street,” and in an interview in CNBC on Tuesday he said investors should look for two things when buying stocks, and avoid one common pitfall.

First, investors should always look at the balance sheet of a company they are considering investing in. A healthy balance sheet can enable growth at a company, compared to a company that is in poor financial health and saddled with debt.

To gauge a company’s balance sheet health, it’s important to look at the company’s debt-to-equity ratio, or how much debt they have relative to their assets.

The second factor to look for when picking individual stocks is a good turnaround story, in which a once-beaten-down company is showing signs of turning around its business, as its stock price should subsequently rebound.

“I think looking for something different. Looking for something that’s a good story… So you have to find a company that’s either a turnaround or a company that’s going to grow,” Lynch said. “You have to be looking for new companies and look at the balance sheet.”

While researching the health and stability of a company’s balance sheet and underlying business trends is important, what’s just as important is not chasing speculative rallies in stocks, according to Lynch. In other words, don’t just buy a stock because it’s going up, he said.

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“People, they’re investing in individual stocks. It’s sad. They’re careful when they buy a refrigerator or an airplane flight. They’re careful of [their] money. Then they’ll hear about a stock on the bus and they’ll put $5,000 to $10,000 in it, and they have no idea what they do,” Lynch said.

“Look at the company. Look at the balance sheet. What is the reason the stock should be higher? The suckers going up is not a good reason,” he added.

And in terms of a potential recession impacting the stock market, Lynch highlighted that this would be nothing new for the economy and markets, and that with so many people expecting a recession, it might happen — or not.

“We’ve had 13 recessions since World War II, and we’ve had 13 recoveries. Maybe we’re going to have one. If this is a recession, it’s probably the most predicted one ever… I cannot predict the future, but this recession is so expected, so predicted, maybe it’s coming. I don’t know,” he said.

Read the original article on Business Insider