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An analysis of the analysis and strategy of legendary investor Peter Lynch, who achieved a compound annual return of 29%

Jamie Cameron
3. 10. 2022
4 min read

Peter Lynch is a very experienced investor who achieved above-average appreciation from 1977-1990, where his average annual return was 29.2%, more than double the S&P500 index. In today's article, you will learn how Peter Lynch analyzed stocks and achieved incredibly high appreciation.

Peter Lynch

Peter Lynch, a mutual fund manager, was the head of the Fidelity Magellan Fund for 13 years. During his tenure, the fund's assets under management grew from $18 million to $14 billion, provided investors with an annual return of 29%, and was the top-rated equity mutual fund.

What does Peter Lynch focus on when analyzing stocks?

  • Earnings growth over the last 5 years must be more than 15% per year, but less than 30% per year (simply put, the company needs to show growth, but it can't be too big of a jump as it may be a short-term trend).
  • Debt-to-equity ratio of less than 1 (the debt-to-equity ratio shows the ratio of the capital the company owns to the capital it borrows).
  • ROE more than 15% (ROE = return on equity, which is a measure of a company's profitability relative to its equity).
  • P/E less than 15 (I probably don't need to explain here, everyone knows the P/E ratio).
  • Institutional stake must be less than 30%.

Analysis is key to Lynch's approach. When examining a company, he seeks to understand the business and prospects of the company, including any competitive advantages, and to evaluate any potential pitfalls. In addition, Lynch also says that an investor cannot make decent profits if the stock was purchased at too high a price.

Lessons from Peter Lynch on how to pick stocks that outperform the market and deliver high returns 👇

(417) Peter Lynch - How to pick stocks - YouTube

Here are other key indicators that Lynch explores 👇

Earnings growth: the earnings growth rate should match the "story" of the company - Extremely high levels of earnings growth rates are not sustainable.

Year-over-year earnings: historical earnings records should be reviewed for stability and consistency. Stock prices cannot deviate from earnings levels for long, so the pattern of earnings growth will help reveal the stability and strength of the company. Ideally, earnings should increase steadily.

Price to Earnings Ratio: A company's earnings potential is the primary determinant of a company's value. The price-to-earnings ratio helps you keep perspective by comparing the current price to the most recently reported earnings.

Price to earnings ratio relative to historical average: This metric shows you the realistic level that is normal for the company. This is another essential part of the analysis that will give you a more or less reality and not a distorted picture.

Price/earnings ratio relative to the industry average: Comparing a company's price/earnings ratio to the industry's price/earnings ratio can help reveal whether a company is profitable. At the very least, however, it leads to questions about why the company is priced differently.

Dividends and payout ratio: Dividends are typically paid by larger companies, and Lynch tends to favor smaller growth companies. However, Lynch suggests that investors who prefer dividend-paying companies should look for companies with the ability to pay out during recessions (as indicated by a low percentage of earnings paid out as dividends) and companies that have a 20- or 30-year history of regular dividend increases.

Conclusion

Today's article has provided another look at Peter Lynch's analysis and strategy, which has a lot to teach us. Although this is his strategy that was successful around 1980, I think it is applicable and usable for your success now.

Please note that this is not financial advice. Every investment must go through a thorough analysis.

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