Do you wonder how the pro stock pickers do it? How are they able to literally sift through hundreds of stocks to find investing gems? One famous fund manager still stands way above the crowd of pro investors, even after leaving his role 24 years ago.
Peter Lynch, who averaged a 29% return over 13 years at Fidelity Investments, tried to keep things simple and not gamble on stocks. Initially, he looked for three things in a stock-
1. Quality
He checked the cash position, inventory levels and debt amount to make sure he wouldn't buy a company that would blow up in his face.
2. Growth
His favourites were stocks that consistently grew earnings 20% – 25% annually. Above 30% became risky because most companies can't sustain that feverish pace for long.
3. Growth rate vs Price
He liked buying stocks at or below 15 times earnings to make sure he wasn't overpaying. However, If he could buy a stock at a price-earnings (PE) ratio that's close to or less than its growth rate (for example, pay a 20 PE for 25% growth), then it may be a real earner.
Now that you have three of the basic steps that helped make Peter Lynch the investing great that he is, here are three stocks that might have made his buy list.
— SEEK Limited (ASX: SEK) is mostly known by its highly successful seek.com.au job search website. It has averaged 21% earnings growth annually over the past five years and doesn't seem to be changing soon. With international investments and acquisitions, its next growth phase will include overseas job markets in highly populated Asian countries. A winning business model with manageable debt means it can expand much further.
— Ramsay Health Care Limited (ASX: RHC), the market leader in operating private hospitals, has also been expanding in Europe and Asia with great success. Long-term earnings growth is about 20%, but for what would regularly be a defensive healthcare stock, that's impressive. After 50 years in business, it has over 210 hospitals and day surgery facilities. People still get sick and injured, so Ramsay Health Care will have a steady stream of business.
— Domino's Pizza Enterprises Ltd (ASX: DMP) probably would have been a star stock for Lynch. He loved chain businesses like restaurants that could transplant a successful business into a new city again and again across the country. Now that Domino's Pizza Enterprises has a 75% stake in Domino's Pizza Japan, it can replicate the great growth there as well. Consensus forecasts are for earnings to grow around 24% annually over the next two years.
Of these three, I think he would really be into Domino's Pizza Enterprises, except the stock is probably priced too high for his PE to growth rule. A 46 PE is just way too high to pay right now. If it comes down from a market sell-off or missed earnings forecast, then that would be a better entry point.
