Friday, January 22, 2010

Peter Lynch Style Investing Today

If you were going to pick one guy in “value investing” who was a vast success, was modest, could explain what he did and was entertaining at the same time it would be Peter Lynch (largely unknown – like many of the more important experts – in N.Z.)

The Motley Fool ran this recently….

January 18, 2010

     Once in a while I like to think about what some of the great investors of the past would do in today's market.  I ask myself, what would Benjamin Graham do or what would Philip Fisher do in today's market climate?  I decided to focus on Peter Lynch for today's thought experiment, and why not?  $1,000 invested in Peter Lynch's Magellan fund from start to finish would have generated $28,000, no small feat considering most mutual fund managers can barely beat out index funds.  He even coined the term "ten-bagger."  He is truly an investing legend and above and beyond all that, a nice guy.  In fact, the proceeds of all of his investment books went to charity (you know you can trust an investment book author when there is no financial incentive for him to write the book in the first place).

     Peter Lynch specialized in investing in companies which he referred to as "fast-growers," companies that could grow earnings over 15 percent a year.  He looked for companies with a PEG of less than 1.2, since he didn't want to overpay for growth.  Also, he hated companies that carried large amounts of debt on the books.  Another important factor, especially in today's market climate, he didn't care about the macroeconomic conditions or where interest rates were going.  Lynch was a stout believer in investing in what you know, otherwise known as your circle of competence.  He liked companies that were simple to understand, ones you could ask your neighbor about.  He looked for companies with low market caps because he wanted to get in before other institutional investors and analysts caught wind of the companies themselves.  Additionally, Peter Lynch liked companies that eat their own lunch; companies with large amounts of insider ownership.  Lastly, Lynch loved companies that carry a lot of cash on the books, especially cash over the stock price (harder to find today).  

     With these considerations in mind I came up with this list of companies that I think Peter Lynch would have looked at today: Life Partners (LPHI), Buckel Inc. (BKE), Gymboree (GYMB), Stepan (SCL), and Orchids Paper Products (TIS).

     Life Partners is a financial services company that purchases life insurance policies at a discount to their face value for investment purposes. This company was named #1 of the fastest growing companies by Fortune.  It has no debt, 1.28 in cash per share, grows equity at 65%, and with a 311m market cap it has very little institutional investment (25%).  This company also has a 4.80% dividend yield to boot.  Insiders own a whopping 50% of this stock.  The only reason Lynch wouldn't invest in this stock is because it doesn't have that ask-your-neighbor-about-their-service type of quality to it.  Other than that it fits right in his wheelhouse.

     Buckle Inc., however, fits right into the ask-your-neighbor category.  Anyone who has been to the mall knows of this trendy clothing retailer. With a 40% ROE, zero debt, $2 of cash per share, 44% insider holding, and a 2.5% dividend yield it is safe to say this is a stock Lynch would be buying.  The only reason he might not like it is that 64% of the stock is held by mutual funds. 

     Gymboree is a popular children's clothing retailer that also has the ask-your-neighbor quality to it.  It is geared to be the new Kids R Us.  ROE is 27%, cash per share is $7, and insider holding is 13%.  However, institutions have largely caught on to this stock and hold 95% (according to yahoo). 

     Stepan is a 660m company which specializes in surfactants, polymers, and specialty products.  For being a fairly large company with strong potential it is surprising that only 55% of the shares are own by mutual funds and institutions.  They've grown earnings at 15% a year, ROE is 22%, insiders hold 22%, and they have a 1.40% dividend yield.  The only reason Lynch might not want this company is that it is more difficult to understand and cash is slightly less than debt (72m vs. 110m).

     Orchids Paper Products is a small paper company (160m cap) that sells paper towels, bathroom tissue, and paper napkins to big retailers like Wal-Mart, Dollar General, and Family Dollar.  This company has grown earnings 168% yoy, holds enough cash to cover its debt, has a 28% ROE, and has an insider holding of 20%.  Lynch would especially like this company because of its aggressive growth strategy.  Only 24% of its shares are held by mutual funds.  For a company with such a tremendous amount of growth ahead of it, I think lynch perhaps would have liked this company best. 

     Although Peter Lynch retired his fund in 1990 his methods are still sound today (in fact, I paid $1.00 for his book "One Up On Wall Street" and it has already made me thousands).  Lynch was always a firm believer that the individual investor could out-perform most mutual funds (and do so without paying fees).  It is my hope that these Peter Lynch style stocks will provide a launching pad for further research into these companies and the Peter Lynch investing style, and will help you too to out-perform mutual fund managers.

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