Peter Lynch is one of the greatest investors of all time - any investor (or anyone involved in the financial markets for that matter) likely has heard of Peter Lynch.
Lynch managed the Magellan Fund at Fidelity from 1977 to 1990 during which the funds assets under management grew from about $18 million to about $14 billion dollars - this is an increase of about 777x, meaning that $1000 invested in the Magellan Fund under Lynch's helm in 1977 would yield about $777,000 in 1990 - an absolutely astounding return that skyrocketed Lynch into the top echelon of investors not only in his generation but in the history of investing.
In case the above numbers aren't enough to convince you of Peter Lynch's investing genius, let's compare the Magellan Fund's performance from 1977 to 1990 with the performance of the Dow Jones Industrial Average over the same time period. The Dow Jones Industrial Average managed an increase of about 3x over the same period - $1000 invested in the Dow would yield a comparably paltry $3000 in 1990.
Clearly, any investor should at least be interested in the general methods employed by Peter Lynch. Although Lynch articulates some general principles regarding his investing philosophy in the now classic One Up on Wall Street, we will look at what can be called a Peter Lynch Stock Screen - a stock screen that generally uses his principals to screen the universe of potential stocks for a small number of potentially lucrative stock picks.
Price Earnings (P/E) Ratio Lower than Industry
The common price to earning (P/E) ratio is often used in stock screening and Peter Lynch was no stranger of this classic and often used metric. By screening for firms that have a lower P/E ratio than the industry, an investor can find potentially undervalued equities.
In order to perform this screen, one would first need to accurately identify the industry. It's key that the industry classification is not too broad - this will create a more accurate comparison. For example, a luxury car company such as BMW might be better grouped with other similar luxury firms (eg. Mercedes Benz, VW Group, etc.) instead of as part of the car industry as a whole (eg. Ford, GM, etc.).
Once an industry P/E ratio is identified all stocks that have a P/E ratio at or above it can be screen out. More conservative investors might even choose a slightly lower P/E in order to more aggressively target deep value plays.
Price Earnings to Growth (PEG) Ratio Less than 1
The Price Earnings to Growth (PEG) ratio is an excellent metric and is especially useful for high-growth firms. The ratio compares the P/E ratio to the growth of earnings per share (EPS) - clearly, firms that have earnings per share (EPS) growth might allow for greater accommodation of higher P/E ratios because you are paying for future growth.
A PEG ratio allows investors to take the P/E into full account by also looking at EPS - it's possible that a relatively high P/E will be viewed in a much better light when the PEG ratio is looked at.
A PEG ratio below one is a low PEG ratio - it can be said that "growth is being purchased cheaply" with a low PEG ratio.
Insider Buying to Selling Ratio Greater than 1.5
This is an interesting thing to look at and it gives us a glimpse into Peter Lynch's thinking. Who has more knowledge of the firm, random investors or insiders? Clearly, insider buying implies optimism about the future prospects of the firm - relying on this easy to see metric requires no real analysis or calculation and is simply based on an understanding of the nature of knowledge and human society.
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