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Peter Lynch

GROWTH

STOCKS

Peter Lynch

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eter Lynch, perhaps the greatest mutual fund manager of all-time, guided Fidelity Investment's Magellan Fund to a 29.2% average annual return from 1977 until his retirement in 1990, almost doubling the S&P 500's 15.8% yearly return over that time. Lynch's common sense approach and quick wit made him one of the most quoted investors on Wall Street. ("Go for a business that any idiot can runbecause sooner or later, any idiot probably is going to run it," is one of his many pearls of wisdom.) Lynch's approach centers on a variable that he is famous for developing: The price/earnings/growth ratio, or "PEG." The PEG divides a stock's price/earnings ratio by its historic growth rate to find growth stocks selling on the cheap. Lynch's rationale: The faster a firm is growing, the higher the P/E multiple you should be willing to pay for its stock. Lynch is known for saying that investors can get a leg up on Wall Street by "buying what they know," but that's really just a starting point for him; his strategy goes far beyond investing in a restaurant chain you like or a retailer whose clothes you buy. Along with the PEG, he focused on fundamental variables like the debt/equity ratio, earnings per share growth rate and net cash. It's important to note that Lynch used different criteria for different categories of stocks, with the three main categories being "fast-growers" (stocks with EPS growth rates of at least 20% per year); "stalwarts" (stocks with growth rates between 10% and 20% and multi-billion-dollar sales); and "slow-growers" (those with single-digit growth rates and high dividend payouts).He also used special criteria for financial stocks. Guru tracking Web site Validea.com's Peter Lynch model portfolio is up 84.6% since inception in 2003 vs. 36.5% for the S&P 500. Included in this report are eight current "Lynch" favorites selected based on the strategies below. P/E Growth Ratio The investor should examine the P/E relative to the growth rate, based on the average of the 3- and 4-year historical EPS growth rates using the current fiscal year EPS estimate, for a company. This is a quick way of determining the fairness of the price. EPS Growth Rate The Lynch-inspired methodology favors companies that have several years of fast earnings growth, as these companies have a proven formula for growth that in many cases can continue many more years. This methodology likes to see earnings growth in the range of 20% to 50%, as earnings growth above 50% may be unsustainable. Total Debt/Equity Ratio Less debt equals less risk according to this methodology. This ratio is one quick way to determine the financial strength of the company. Sales and P/E Ratio For companies with sales greater than $1 billion, this methodology likes to see the P/E ratio remain below 40. Large companies can have a difficult time maintaining a growth rate high enough to support a P/E above this threshold. Net Cash Position A bonus for a company is having a Net Cash/Price ratio above 30%. Lynch defines net cash as cash and marketable securities minus long-term debt. According to this methodology, a high value for this ratio dramatically cuts down on the risk of the security. Keep in mind, however, that a low Net Cash/Price ratio does not adversely affect the company as it is a bonus criterion. Source: Validea.com

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GT ADVANCED TECHNOLOGIES (GTAT)

Provides equipment and services for the solar and LED industries P/E Growth (PEG): 0.14 P/E: 6.24 EPS Growth: 45.8% Total Debt/Equity: 0 Sales: $873.4M Net Cash Position: 38.1%

Source: Yahoo Finance

KULICKE & SOFFA INDUSTRIES (KLIC)

Designs and manufactures semiconductor assembly equipment P/E Growth (PEG): 0.19 P/E: 7.08 EPS Growth: 36.4% Total Debt/Equity: 22.2 Sales: $801.6M Net Cash Position: 44.4%

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Source: Yahoo Finance 3

OMNIVISION TECHNOLOGIES (OVTI)

Designs, develops and markets semiconductor image-sensor devices P/E Growth (PEG): 0.44 P/E: 11.22 EPS Growth: 25.3% Total Debt/Equity: 5.8 Sales: $937.5M Net Cash Position: 42.7%

Source: Yahoo Finance

HUMANA (HUM)
Offers health and supplemental benefit products P/E Growth (PEG): 0.46 P/E: 10.40 EPS Growth: 22.8% Total Debt/Equity: NA Sales: $36.8B Net Cash Position: 52.2%

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Source: Yahoo Finance 4

INTERNATIONAL RECTIFIER (IRF)

Designs, manufactures and markets power management semiconductors P/E Growth (PEG): 0.57 P/E: 14.54 EPS Growth: 25.4% Total Debt/Equity: 0 Sales: $1.1B Net Cash Position: 33.0%

Source: Yahoo Finance

TERNIUM (TX)
Latin American company that manufactures and processes flat and long steel products P/E Growth (PEG): 0.62 P/E: 8.92 EPS Growth: 10.8% Total Debt/Equity: 34.6 Sales: $9.2B Net Cash Position: 35.8%

Source: Yahoo Finance

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TECH DATA (TECD)

Distributes information technology products and offers logistics management P/E Growth (PEG): 0.44 P/E: 11.60 EPS Growth: 26.3% Total Debt/Equity: 5.4% Sales: $26.5B Net Cash Position: NA

Source: Yahoo Finance

FOREST LABORATORIES (FRX)

Develops, manufactures and sells branded and generic forms of ethical drug products P/E Growth (PEG): 0.57 P/E: 8.27 EPS Growth: 14.5% Total Debt/Equity: 0% Sales: $4.7B Net Cash Position: 43.7

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Source: Yahoo Finance 6