Peter Lynch was one of the most successful mutual fund managers in history, averaging a 29.2% annual return while managing Fidelity’s Magellan Fund from 1977 to 1990. Validea’s Lynch-inspired strategy aims to capture the key principles of Lynch’s investing approach.
The strategy first categorizes stocks into three main groups:
- Fast-growers: 20%+ annual EPS growth
- Stalwarts: 10-19% annual EPS growth, multi-billion dollar sales
- Slow-growers: <10% annual EPS growth
For all stocks, regardless of category, the strategy looks at:
- P/E/G ratio: Price-to-earnings ratio divided by EPS growth rate. Lower is better, ideally below 1.0. For stalwarts and slow-growers, dividend yield is added to growth rate.
- Inventory-to-sales ratio: Should not be increasing substantially faster than sales.
- Debt-to-equity ratio: Should be below 80% (except for financials and utilities).
- For financial stocks: Equity-to-assets ratio should be at least 5% and return on assets at least 1%.
Additional criteria are then applied based on the stock’s category:
Fast-growers:
- P/E below 40 if sales >$1 billion
- EPS growth between 20-50%
Stalwarts:
- Sales at least $1.9 billion
- Positive EPS
Slow-growers:
- Sales at least $1 billion
- Dividend yield higher than S&P 500 average and at least 3%
The strategy also gives bonus points for high free cash flow yield and net cash as a percentage of share price.
Lynch favored companies with “dull” products or business models that were easy to understand. He believed individual investors could gain an edge by investing in companies they encounter in their daily lives, before Wall Street caught on. However, he emphasized thorough fundamental analysis after identifying potential investments this way.
Here are the top ten highest scoring stocks for July 2024 for Validea’s P/E/Growth Investor strategy based on Peter Lynch.
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