Peter Lynch Investing Screen: Searching for undiscovered growth stories

Tuesday, Apr 19 2011 by
11
Peter Lynch Investing Screen Searching for undiscovered growth stories

In Brief

A “fast growers” screen which looks for consistently profitable, relatively unknown, low-debt, reasonably priced stocks with high, but not excessive, growth 

Background

Mr. Lynch developed his investment philosophy at Fidelity, and gained his considerable fame managing Fidelity's Magellan Fund. The fund was among the highest-ranking stock funds throughout Mr. Lynch's tenure, which began in 1977 at the fund's launching, and ended in 1990 when Mr. Lynch retired. His selection approach is strictly a bottom-up "buy what you know" one. He suggested focusing on companies familiar to the investor, applying fundamental analysis which emphasizes a thorough understanding of the company, its prospects, its competitive environment, and whether the stock can be purchased at a reasonable price. Lynch says he would rather invest in "pantyhose rather than communications satellites," and "motel chains rather than fiber optics".

He warns against diversification for diversification's sake, particularly if it means less familiarity with the firms. Instead, one should to invest in whatever number of firms is large enough to allow you to fully research and understand each firm.

He suggests categorizing a company by "story" type, and he identifies six archetypes:

  • Slow Growers: Large / aging companies growing only slightly faster than the economy as a whole, but often paying regular dividends. 
  • Stalwarts: Large companies that are still able to grow, with annual earnings growth rates of around 10% - 12% (e.g Coca-Cola & Procter & Gamble).
  • Fast-Growers: Small, aggressive new firms with annual earnings growth of 20% - 25% a year.
  • Cyclicals: Companies in which sales and profits tend to rise and fall in somewhat predictable patterns based on the economic cycle (e.g. auto, airline and steel sector).
  • Turnarounds: Companies that have either pulled themselves out of a serious slump, or got bailed by by the government
  • Asset plays: Companies where the assets exceeds its market cap.

The screen below focuses on the small, moderately fast-growing companies bought at a reasonable price, which Lynch tended to favour.

Calculation / Definition

It’s frankly impossible to come up with a screen that exactly replicates Lynch’s multi-faceted investing strategy. Nevertheless, the following approach seeks to emulate some of the key elements of his search for “fast growers”:

  • Annual EPS Growth Rate >= 15% but <= 30%. Lynch felt that earnings growth was a primary driver of stock prices. However, he was…

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2 Comments on this Article show/hide all

Anime 28th May 1 of 2
3

If his idea is suppose to exclude the Financial sector, why does the screener here fail to exclude that sector?

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sminers 30th Jul 2 of 2
1

I think this question deserve a reply.

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