In 1990, in a suburb outside of Boston, something unusual happened…#-ad_banner-#

As part of their schoolwork, seventh graders at the St. Agnes School in Arlington, Mass. were asked to pick stocks for a model portfolio.

In the following two years, the students’ stock picks produced a 70% gain while the S&P 500 gained 26% during the same time period.

What was even more impressive, however, was that during the same time period, the students’ stock picks outperformed 99% of all equity mutual funds.

The story came to the attention of legendary investor Peter Lynch. At the time, Lynch was in charge of investing more than $14 billion through the Magellan Fund. After receiving a scrapbook from the students’ teacher, Joan Morrissey, he made an appointment to meet with the class to learn the secrets behind their success.

As Ms. Morrissey explained, here was the first lesson:

1. Know What The Company Does

“Before my students can put any stock in the portfolio, they have to explain exactly what the company does. If they can’t tell the class the service it provides or the products it makes, then they aren’t allowed to buy.” What if every investor had to follow this rule? My guess is a lot fewer people would have lost their shirts buying shares of companies that specialize in “collateralized mortgage obligations” or “reverse index amortizing swaps.” Following this rule led the kids to stocks like The Walt Disney Co. (NYSE: DIS), Nike Inc. (NYSE: NKE) and the Gap Inc. (NYSE: GPS) — all companies that make easy-to-understand products. Companies that create products (and brands) that even 13-year-olds can understand will, in the long run, outperform companies that depend on a lot of financial hocus-pocus. The savings and loan crisis of the 1980s and 1990s, and more recently, the collapse of Lehman Brothers, demonstrate what happens when investors forget lesson No. 1. Which leads us to lesson No. 2…

2. Invest In Brands You Know And Love

The kids loved to shop at the Gap. They reasoned their selection saying that other kids around the country probably felt the same way. They must have been right…The Gap posted a 320% gain for the model portfolio. Another clear winner was Pentech International (acquired by Semcon Ab in 2005), a maker of pens and markers. One of the kids’ favorite products was a pen with a marker on one end and a highlighter on the other. Along with the model portfolio, the students sent Lynch a Pentech pen and recommended that he look into the company. He didn’t, and later regretted it when the stock nearly doubled to $9.50 a share. The kids also invested in Topps baseball cards (taken private in 2007) for a 55% gain, Pepsi (NYSE: PEP) for a gain of 64%, and Wal-Mart (NYSE: WMT) for a 164% gain. Not all the picks were winners. Savannah Foods (taken private in 2004) fell 38%. But in making this pick, the students broke rule No. 2. They hadn’t picked the stock because they knew the company; they selected it because they had read Investor’s Daily. Now, critics and naysayers might point out that it wasn’t real money being invested. But as Lynch said, “So what? The pros ought to be relieved that St. Agnes wasn’t working with real money– otherwise, based on St. Agnes’s performance, billions of dollars might be pulled from the regular mutual funds and turned over to the kids.” Other critics might say, “Anybody could have picked those stocks.” And to quote Lynch again: “If so, why didn’t anybody?” After visiting the classroom and inviting the kids to his office for pizza, Lynch was happy to receive in the mail one day, a cassette on which the students had recorded some of their investing mantras. Here are three of my favorites: You can lose money in a very short time, but it takes a long time to make money. You shouldn’t just pick a stock — you should do your homework. You should not buy a stock because it’s cheap, but because you know a lot about it. The last two mantras simply reinforce lesson No. 3. Kids hear this lesson every day, and the irony is many experienced investors often overlook it.

3. Do Your Homework

In the following years, Ms. Morrissey continued to teach her students how to pick stocks, but she was also inspired to start an investing group made up of other teachers, with Peter Lynch serving as an honorary member. The group called themselves the “Wall Street Wonders.” One day, after going over the numbers with Lynch, she realized that while the group’s returns were good, they were still not as good as the students’ results. “Wait until I tell the other teachers that the kids’ stocks have done better than ours,” she said.

Action to Take –> Making money in the stock market isn’t hard. But making significant and consistent returns over the years is a different story. When it comes to successful investing, you don’t need complex formulas and solutions. These three simple investing rules are so effective, even Wall Street’s brightest minds want to learn them.

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