Peter Lynch’s legendary investment approach combined growth and value principles to identify companies trading at attractive prices relative to their growth rates. Validea’s interpretation of Lynch’s methodology focuses on his famous PEG ratio (Price/Earnings relative to Growth) while incorporating other key fundamental factors. For technology companies, this disciplined framework can help identify promising growth stories that haven’t become overvalued.
Understanding the Lynch Model
The cornerstone of Lynch’s strategy is finding companies with P/E ratios that are lower than their growth rates, resulting in PEG ratios below 1.0. But Lynch didn’t stop there – he also analyzed inventory trends, debt levels, and cash flow generation to ensure companies had strong fundamentals supporting their growth. For larger companies (over $1B in sales), Lynch wanted P/E ratios below 40 to avoid overvalued situations.
Why It Works for Tech Stocks
Technology companies often deliver strong earnings growth but can become overvalued during periods of market enthusiasm. Lynch’s methodology helps identify tech stocks that maintain reasonable valuations despite their growth characteristics. By focusing on PEG ratios and fundamental factors like debt levels, investors can find tech companies with both growth potential and margin of safety.
Here are 5 technology companies that currently score highly on Validea’s Lynch-based model:
Applied Materials (AMAT)
- Impressive 91% score on Lynch model
- PEG ratio of 0.92 based on 24.9% historical EPS growth rate
- P/E of 22.9 is reasonable for $26.8B in sales
- Strong inventory management with inventory/sales ratio decreasing 1.42% year-over-year
- Moderate debt/equity ratio of 33.7%
- Also scores 100% on Warren Buffett model due to consistent earnings growth and strong returns on equity
Benchmark Electronics (BHE)
- Outstanding 93% Lynch model score
- Very attractive PEG ratio of 0.48 with 48.8% historical growth rate
- P/E of 23.2 shows reasonable valuation despite high growth
- Improving inventory management with 1.13% decrease in inventory/sales ratio
- Conservative debt/equity ratio of 26.4%
- Also ranks highly (100%) on Twin Momentum model due to strong price and fundamental momentum
Cirrus Logic (CRUS)
- Strong 91% Lynch model score
- PEG ratio of 0.94 reflects solid value relative to 23.7% growth
- P/E of 22.2 remains reasonable
- Minor inventory increase of 0.4% year-over-year is acceptable
- Zero debt provides exceptional financial strength
- Also scores 94% on Twin Momentum model due to fundamental improvements
Photronics (PLAB)
- Perfect 100% Lynch model score
- Extremely attractive PEG ratio of 0.23
- Low P/E of 10.5 despite 45.8% historical growth rate
- Improving inventory efficiency with 0.55% decrease in inventory/sales
- Minimal debt/equity ratio of 1.9%
- Also scores 94% on Acquirer’s Multiple model due to attractive valuation metrics
Qualcomm (QCOM)
- Strong 91% Lynch model score
- PEG ratio of 0.95 shows good value relative to 22.7% growth
- P/E of 21.6 remains reasonable for large-cap tech
- Moderate inventory increase of 3.6% within acceptable range
- Manageable debt/equity ratio of 59%
- Also scores 77% on Partha Mohanram growth model due to strong R&D investment and profitability
Why These Stocks Stand Out
These five companies exemplify what Lynch looked for – strong growth rates combined with reasonable valuations. Their PEG ratios all fall below 1.0, indicating their P/E ratios are lower than their historical growth rates. Additionally, they maintain solid fundamental characteristics with controlled inventory levels and reasonable debt.
The diverse business models represented – from semiconductor equipment (AMAT) to electronics manufacturing (BHE) to mobile technology (QCOM) – show how Lynch’s principles can identify opportunities across different technology subsectors.
Further Research
