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This Powerful Chart Made Peter Lynch 29% a Year for 13 Years

June 25, 2013 | About:
GuruFocus

GuruFocus

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In his excellent book One Up on Wall Street, Peter Lynch, the best mutual fund manager ever, revealed a powerful charting tool that helped him to achieve a gain of 29.2% in his portfolios for 13 years. In this chart, Peter Lynch drew the stock price and the earnings per share together and aligned the value of $1 in earnings per share to $15 in stock price. He wrote in pages 164-165 of the book:

“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 chances are you’d do pretty well.”

To see how this Peter Lynch Chart works, we applied it to the top holdings of Warren Buffett, the most successful investor ever: Wells Fargo (NYSE:WFC), Coca-Cola (NYSE:KO), IBM (NYSE:IBM), American Express (NYSE:AXP) and Wal-Mart (NYSE:WMT). The Peter Lynch Chart of Wells Fargo is below, where the green line is the Price Line, and the blue line is the Peter Lynch Earnings Line. When the Price Line is well below the Peter Lynch Earnings Line, the stock is a buy.

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Among these top five holdings of Warren Buffett, we found that Wells Fargo is the most undervalued. Wal-Mart and IBM are about fair valued. We then compared this result with the trading activities of Warren Buffett. To our surprise, we found that Warren Buffett was buying Well Fargo heavily and adding to Wal-Mart and IBM.

Is this just a coincidence? Does Warren Buffett only buy the stocks that are undervalued as measured by the Peter Lynch Chart? Is Warren Buffett using this powerful tool, too?

We don’t know the answer to the question. But we know that great minds think alike!

Now this powerful charting tool is available at GuruFocus.com. You can create it in just two clicks for any of the more than 50,000 stocks covered by GuruFocus.com.

We applied this tool to the portfolios of George Soros, Carl Icahn and other investment Gurus tracked at GuruFocus.com. We even developed a screen for this strategy that makes it easy to find stocks that are traded well below Peter Lynch’s Earnings Line.

Certainly buying stocks that are traded well below their Earnings Line is not the only criterion Peter Lynch used to achieve his 29%-a-year results. We also added his other requirements such as strong balance sheet and solid growth into the screener. When I limit my Peter Lynch screen to only the stocks that are owned by Warren Buffett, I found seven othereight companies that Warren Buffett owns and Peter Lynch would be buying. All of these eight companies have strong balance sheet, solid growth and reasonable valuations. One of them is of course Wells Fargo. Warren Buffett loves it so much that he made it his largest holding.

Now both Warren Buffett and Peter Lynch are working for me! I have added these stocks to my watch list.

[Note: If you'd like to learn more about this Peter Lynch + Warren Buffett screener, the Peter Lynch Chart and other powerful valuation tools on GuruFocus.com, your GuruFocus Premium Membership allows you to do so. If you are not a Premium Member, visit this link]


Rating: 2.6/5 (34 votes)

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Comments

Nuclearhab
Nuclearhab - 1 year ago

"where the green line is the Price Line, and the blue line is the Peter Lynch Earnings Line"

Am I missing something? Don't you mean where the blue line is the Price line and the green line the Earnings Line?

Alex Garcia
Alex Garcia - 1 year ago

I don't see the article?

gh1
Gh1 - 1 year ago

Where is the article or chart?

sorenfl
Sorenfl premium member - 1 year ago

Yeah, we wonna see it !

iamackenzie
Iamackenzie premium member - 8 months ago

Same comment as Nuclearhab: the text and legend are in contradiction. The legend appears to be right and the text has it backwards. At least I hope that is the case or I am totally confused.

iamackenzie
Iamackenzie premium member - 8 months ago

Same comment as Nuclearhab: the text and legend are in contradiction. The legend appears to be right and the text has it backwards. At least I hope that is the case or I am totally confused. But I just found out why this happened. If you actually go to the interactive chart the color scheme there is opposite of the chart shown here.

cordwainer
Cordwainer - 6 months ago

Pathetic. You should not buy any one stock just because the P/E is below 15.

westes
Westes premium member - 3 months ago

The article is not clear at all. You fail to define the study in a way that lets others duplicate the result.

What it almost looks like you are saying is to compare the price of the stock to a theoretical price line that values the company at 15x earnings. But that cannot be right because 15 is totally overvaluing a commodity business but might significantly undervalue a growth business with a strong moat.

It's really not clear how you want to generalize this.

rjk
Rjk - 3 weeks ago

To bring this formula out of obfuscation mode and into plain English, is Lynch saying to multiply the EPS times 15 and if the number you get is higher than the stock price the stock is undervalued and if the stock price is higher than the number calculated the stock is overpriced? Or is there some other explanation?

SeekingKuber
SeekingKuber - 1 day ago

Just because a stock is undervalued (using whatever metric one may choose) does not mean one should buy it. The investor will need to understand why it is so. There is almost certainly a reason and an investor needs to be quite certain that the reason for undervaluation is temp not caused by business fundementals. There is way too much risk in oversimplyfing investent decisions , I doubt the author meant for that to be main take-away.

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