In a previous article I wrote on a value comparison tool that former Fidelity fund manager Peter Lynch used to get a general reading on how a stock might be selling at a discount compared to its dividend yield and earnings growth. To use the tool you add the dividend yield and long-term average annual earnings growth rate as numbers, not percentages, and divide the total by the stock's current PE ratio. A result of 1.5 or more is desirable.
A company may be having an incredible year with flying earnings, but the PE ratio may be just as high-flying, so you are paying a much higher premium for the price of admission. We want to find those companies that are selling at a discount compared to their usual earnings growth. Short-term events may bring down earnings or market sentiment towards the company may be dismal. This is when buying opportunities may arise. This investor tool is a good way to guide your first investigations.
There are three companies to examine in the S&P ASX 100 Index (ASX: ^XTO) that had a 1.5 result or better under the Lynch tool.
Monadelphous Group (ASX: MND)
This engineering and mining services company recently slipped down to $14.63 when earnings estimates were revised down. It has since recovered back to $17.74 and may have been oversold according to the Lynch tool.
Beach Energy (ASX: BPT)
The oil and gas production company increased its 2013 NPAT by 15.3%. With exposure to the LNG industry through its Cooper Basin developments, the next two years will see more business potential as LNG exports begin out of Gladstone, QLD.
Iluka Resources (ASX: ILU)
Is a major producer of zircon and one of the largest producers of rutile and synthetic rutile, which can be used for pigment in paints, plastics and paper. Earnings were way down in 2008-2009, but in recent years have recovered substantially. Improving housing markets can benefit the company as more paint is used in housing construction.
See the table below for a summary of relative company strengths.
|
Dividend Yield |
10-year NPAT annual compound growth rate |
PE Ratio |
Lynch Value Tool |
|
| Monadelphous Group |
7.72% |
36.00% |
10.91 |
4.01 |
| Beach Energy |
1.94% |
34.50% |
13.16 |
2.77 |
| Iluka Resources |
4.00% |
12.70% |
9.70 |
1.72 |
Foolish takeaway
The Lynch value tool is just the first step in finding companies that may be selling at a discount to their potential earnings and dividend payment. Similar to the PE ratio itself, it is a general guide of value to price, but not the sole reason for buying a stock. Past performance is no guide to future performance. But long-term past performance can at least cover more than one business cycle. This gives you a perspective on how the company performed in good times and bad.
