Warren Buffett and Peter Lynch are two of the most renowned investors of all time, each with their own distinct approach to finding winning stocks. While their strategies differ in many ways, there is some overlap in the types of companies they seek out. By identifying stocks that satisfy both Buffett’s and Lynch’s criteria, investors can potentially find high-quality companies with strong fundamentals and attractive valuations.
Validea has developed quantitative models based on the published writings and strategies of Buffett, Lynch, and other legendary investors. In this article, we’ll examine five stocks that currently pass both Validea’s Buffett-inspired “Patient Investor” model and its Lynch-based “P/E Growth Investor” model. We’ll explore the key criteria of each strategy and analyze why these particular stocks are favored by both models.
Understanding the Buffett Model
Validea’s interpretation of Warren Buffett’s investment approach is based on the book “Buffettology” by Mary Buffett. The “Patient Investor” model seeks companies with:
- Consistent and predictable earnings growth over the past 10 years
- Strong return on equity (ROE) of at least 15% on average over the past decade
- Low debt levels or the ability to pay off debt with earnings within 2 years
- Positive free cash flow
- Management that effectively utilizes retained earnings to benefit shareholders
- An attractive initial rate of return compared to long-term Treasury yields
- A projected long-term return of at least 15% based on earnings growth and valuation
Understanding the Lynch Model
Peter Lynch’s strategy, as interpreted by Validea, centers around the famous price-to-earnings growth (PEG) ratio. The “P/E Growth Investor” model looks for:
- A favorable PEG ratio (P/E divided by the earnings growth rate)
- Strong earnings growth, ideally between 20-50% annually
- A reasonable P/E ratio relative to the company’s growth rate
- Low debt-to-equity for non-financial companies
- Inventory levels growing slower than sales (for applicable industries)
- Strong free cash flow (as a bonus factor)
Now let’s examine the five stocks that currently satisfy both models with perfect scores:
Five Below is a rapidly growing discount retailer targeting teens and pre-teens with products priced at $5 or less.
Why it passes the Buffett model:
- Consistent earnings growth: EPS has grown from $0.88 in 2015 to $5.41 in 2024
- Strong ROE: 21.8% average over the past decade
- No long-term debt
- Positive free cash flow of $2.96 per share
- Management has delivered a 16.1% return on retained earnings
- Projected long-term return of 18.2% based on Validea’s analysis
Why it passes the Lynch model:
- Favorable PEG ratio of 0.79
- Strong EPS growth rate of 19.6%
- P/E ratio of 14.1, well below the 40 threshold for fast-growing companies
- No long-term debt
- Inventory growth (13.76%) slower than sales growth (19.2%)
Alphabet, the parent company of Google, is a global technology leader in search, advertising, cloud computing, and other digital services.
Why it passes the Buffett model:
- Consistent earnings growth: EPS has grown from $0.99 in 2015 to $5.97 in 2024
- Strong ROE: 18.5% average over the past decade
- Low debt relative to earnings
- Positive free cash flow of $5.46 per share
- Management has delivered a 17.2% return on retained earnings
- Projected long-term return of 16.9% based on Validea’s analysis
Why it passes the Lynch model:
- Favorable PEG ratio of 0.79
- Strong EPS growth rate of 28.9%
- P/E ratio of 22.8, well below the 40 threshold for fast-growing companies
- Low debt-to-equity ratio of 4.71%
3. LPL Financial Holdings Inc (LPLA)
LPL Financial is the largest independent broker-dealer in the United States, providing technology, brokerage, and investment advisory services to financial advisors.
Why it passes the Buffett model:
- Consistent earnings growth: EPS has grown from $1.75 in 2015 to $13.69 in 2024
- Strong ROE: 33.0% average over the past decade
- Strong return on assets (ROA) of 6.4% on average
- Positive free cash flow of $0.22 per share
- Management has delivered a 26.4% return on retained earnings
- Projected long-term return of 19.2% based on Validea’s analysis
Why it passes the Lynch model:
- Extremely favorable PEG ratio of 0.36
- Strong EPS growth rate of 27.7%
- P/E ratio of 17.1, well below the 40 threshold for fast-growing companies
- As a financial company, it passes Lynch’s criteria for return on assets (9.33%) and equity-to-assets ratio (22%)
4. Lululemon Athletica Inc (LULU)
Lululemon is a leading athletic apparel retailer known for its yoga-inspired clothing and accessories.
Why it passes the Buffett model:
- Consistent earnings growth: EPS has grown from $1.66 in 2015 to $12.20 in 2024
- Strong ROE: 27.6% average over the past decade
- No long-term debt
- Positive free cash flow of $12.94 per share
- Management has delivered a 22.2% return on retained earnings
- Projected long-term return of 17.7% based on Validea’s analysis
Why it passes the Lynch model:
- Favorable PEG ratio of 0.62
- Strong EPS growth rate of 33.2%
- P/E ratio of 20.6, well below the 40 threshold for fast-growing companies
- No long-term debt
- Inventory growth (13.76%) slower than sales growth (19.2%)
Preferred Bank is a commercial bank focused primarily on the California market, offering a range of financial services to businesses and individuals.
Why it passes the Buffett model:
- Consistent earnings growth: EPS has grown from $1.78 in 2015 to $10.52 in 2024
- Strong ROE: 15.2% average over the past decade
- Strong return on assets (ROA) of 1.5% on average
- Positive free cash flow of $9.94 per share
- Management has delivered a 22.7% return on retained earnings
- Projected long-term return of 18.0% based on Validea’s analysis
Why it passes the Lynch model:
- Extremely favorable PEG ratio of 0.36
- Strong EPS growth rate of 21.3%
- P/E ratio of 7.6, well below the industry average
- As a financial company, it passes Lynch’s criteria for return on assets (2.09%) and equity-to-assets ratio (11%)
- Strong net cash position relative to its price (73.37%)
The Power of Combining Strategies
These five stocks – Five Below, Alphabet, LPL Financial, Lululemon, and Preferred Bank – demonstrate that it’s possible to find companies that satisfy the stringent criteria of both Warren Buffett and Peter Lynch. By passing both models, these stocks exhibit a rare combination of qualities:
- Consistent, predictable earnings growth
- Strong returns on equity and efficient use of capital
- Solid balance sheets with manageable debt levels
- Attractive valuations relative to their growth rates
- Positive free cash flow generation
By combining the patient, value-oriented approach of Warren Buffett with the growth-at-a-reasonable-price strategy of Peter Lynch, investors may be able to identify high-quality companies poised for long-term success.
Further Research
