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Can You Find Undervalued Stocks in This Market? Peter Lynch Chart Says Yes

Holly LaFon

Holly LaFon

255 followers
In his book, “One Up on Wall Street,” Lynch described a process of valuing stocks to predict whether they would provide a good or meager return to investors.

This is how Peter Lynch describes his process: “A quick way to tell if a stock is overpriced is to compare the price line to the earnings line. If you bought familiar growth companies – such as Shoney’s, The Limited, or Marriott – when the stock price fell well below the earnings line, and sold them when the stock price rose dramatically above it, the changes are you’d do pretty well.”

As examined yesterday, GuruFocus tools can easily create a chart of Peter Lynch Fair Value for any stock in just two steps:

1. Click on Price at P/E = 15

2. Click on Logarithmic on the top right corner

Peter Lynch says that the best time to buy a stock is when the green line goes below the blue line, as in the case of Wal-Mart:

1369778220853.png

“In this case, it would be around the middle of 2011. Indeed, if you bought Wal-Mart in June 2011 at around $54, you have gained more than 40% in about two years,” GuruFocus wrote yesterday. “Not bad from a large company like Wal-Mart.”

Using Peter Lynch

We can use this method to create a chart and determine whether each of the 30 stocks in the Dow Jones Industrial Average is undervalued or overvalued.

3M Co. (MMM)

1369856227006.png

According to the chart, the green line was below the blue line for much of 2011 and 2012, but it has surpassed the green line substantially now. This indicates that 3M was recently a good bargain, but is now overvalued.

Alcoa (AA)

1369861311557.png

Alcoa also appears overvalued.

American Express Co. (AXP)

1369856505616.png

American Express’ green line has exceeded its blue line for much of 2013, indicating that investors could not expect a good return on this stock if they bought it now.

AT&T (T)

1369861527851.png

AT&T appears overvalued.

Bank of America (BAC)

1369861614882.png

Bank of America appears overvalued.

Boeing (BA)

1369857439463.png

For Boeing, the green line topped the blue line also beginning around this year, indicating overvaluation.

Caterpillar Inc. (CAT)

1369861689578.png

The green line is lower than the blue line, meaning Caterpillar is undervalued.

Chevron (CVX)

1369861663195.png

Green below blue – good value.

Cisco Systems Inc. (CSCO)

1369858115499.png

Chevron appears undervalued.

E.I. du Pont de Nemours & Company (DD)

1369858215307.png

This stock has flip-flopped from overvalued to undervalued already this year.

Exxon Mobile Corporation (XOM)

1369858293626.png

The chart indicates that Exxon has been in a state of undervaluation since early 2010.

General Electric Co. (GE)

1369863363753.png

Green is above blue – overvalued.

Hewlett Packard (HPQ)

1369861732372.png

Hewlett-Packard appears unclear, because it has a loss.

Home Depot (HD)

1369864018371.png

Home Depot appears overvalued.

Intel Corp. (INTC)

1369858675852.png

Intel appears undervalued.

IBM Corp. (IBM)

1369858747067.png

IBM appears undervalued.

Johnson & Johnson (JNJ)

1369859576612.png

Johnson & Johnson appears overvalued.

JPMorgan Chase (JPM)

1369859627471.png

JPMorgan Chase appears undervalued since 2010.

McDonald’s Corp. (MCD)

1369860049404.png

It appears the last few years have not been a good time to buy McDonald’s.

Merck & Co. Inc. (MRK)

1369860113389.png

Merck & Co. appears overvalued.

Microsoft (MSFT)

1369860225389.png

Microsoft recently became overvalued.

Pfizer (PFE)

1369860533347.png

Pfizer appears undervalued.

Procter & Gamble (PG)

1369860605594.png

Procter & Gamble appears overvalued.

Coca-Cola Co. (KO)

1369860679071.png

Coca-Cola appears overvalued.

Travelers Companies (TRV)

1369860746764.png

Travelers companies appears undervalued.

United Technologies Group (UTX)

1369860777712.png

United Technologies Group appears undervalued.

United Health Group Inc. (UNH)

1369860828802.png

United Health Group appears undervalued.

Verizon Communications (VZ)

1369860870098.png

Verizon Communications appears overvalued.

Wal-Mart Stores Inc. (WMT)

1369860905077.png

Wal-Mart appears overvalued.

Walt Disney Co. (DIS)

1369861201100.png

Walt Disney appears overvalued.

Conclusion

According to the Peter Lynch Fair Value method, 17 out of the 29 decipherable (excluding Hewlett-Packard, which had a loss) companies appeared overvalued, and 12 appeared undervalued, suggesting investors can still find strong possibilities for return in what many are calling an overvalued market.

Try a Peter Lynch Chart here.

Rating: 3.8/5 (18 votes)

Comments

AlbertaSunwapta
AlbertaSunwapta - 1 year ago
Despite the number of very positive votes, I don't find this overly useful or indicative.

Look at the number of instances where the price exceeded the blue line in 2009 and the stock went on to substantial gains while in other instances undervaluation led to nothing good for the buyer of undervaluation at that time.

moreover in more stable pre-crisis times any decisions to buy or sell based on this indicator could have led to substandard returns.
DouginHartford
DouginHartford premium member - 1 year ago
Another consideration is that Peter Lynch's approach, good for retailers and other companies that revert to a P/E figure, does not always fit all types of companies. Property-casualty insurers, for example (Warren Buffett's own Berkshire Hathaway is one example for which Buffett himself declared the intention to buy in shares when under 120% of book) tend to revert to a low multiple of book value, rather than as a multiple of their sometimes catastrophe-impacted earnings (look at the effects of the 2005 hurricane season and when available the effect of Hurricane Sandy). Resources companies, like mining companies, energy exploration and production companies and others, are another example that tend to trade relative to book value.

Further, P/E ratios are figured on trailing Earnings, which can trail price, so a current dip in price relative to Price @ PE=15 may be a clue that "smart money" is anticipating a downturn in E.

It would be useful to me to have a stat election for Price @ ShillerPE=[X]. Shiller P/E (aka Cyclically Adjusted Price Earnings Ratio or CAPE) takes a ten-year average earnings and divides it into Price.

So, Lynch was a great investment guru but this simple formula should be merely a starting place for identifying a good prospect for current investment.
jonmonsea
Jonmonsea premium member - 1 year ago
Yes, Schiller PE would be better. If GuruFocus added that, it would be useful. Obviously, BAC and IBM are not both subject to mean reversion at unadjusted PE of 15.
AlbertaSunwapta
AlbertaSunwapta - 1 year ago
I think lynch's key words were "fell well below" and "rose dramatically above" so I don't think the Shiller PE would add much insight, though it would be interesting to see a comparison.

"when the stock price fell well below the earnings line, and sold them when the stock price rose dramatically above it, the chances are you’d do pretty well.”
boutch2fr
Boutch2fr - 1 year ago
I still find WMT and IBM charts quite amazing...
pravchaw
Pravchaw premium member - 1 year ago
So we buy below PE 15 and sell at PE above 15. What is magical about PE 15?
gurufocus
Gurufocus premium member - 1 year ago
Apparently P/E=15 is what Peter Lynch thinks a fair P/E for most of companies. If you always buy when P/E is much lower than 15, and sell when it is far above, you will do well.
jeff.pohlmeyer
Jeff.pohlmeyer premium member - 1 year ago
I feel like the Price vs P/E=15 is not necessarily a good indicator for Dow Jones stocks. These stocks are generally going to be stalwarts or slow growers, and if you were to use this indicator by itself you'd get yourself minimal returns. As DouginHartford mentioned, this should just be a starting point. You'd want to look at some other figures, as well, such as free cash flow, ROE/ROA, revenue, etc. I don't care what the P/E is or if the P/E=15 line is below or above the price line if the company is not seeing free cash flow increase with an increase in revenue (unless cash is being reinvested into a growing business).

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