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Screening Stocks Using Peter Lynch Charts Approach: Which Stock Price Is Most Correlated to Book Value, Earnings, Sales, EBITDA and Operating Income?

October 07, 2013 | About:
Vera Yuan

Vera Yuan

89 followers
Peter Lynch used many charts in his book “One Up on Wall Street” to do stock valuation. He believed a quick way to tell if a stock is overpriced is to compare the price line to the earnings line. He wrote: “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.”

In his charts, Peter Lynch used a P/E ratio of 15 to drew the so called “earnings line,” which is to use companies’ trailing-twelve-month earnings multiplied by 15 to predict the future prices of the stock. The charts are in logarithmic scale. According to Peter Lynch, the best buying time will be when the price line is lower than the earnings line. Using GuruFocus Financial Charts tools, you can easily access Peter Lynch Charts of more than 50,000 stocks worldwide. For instance, you can get Wal-Mart Stores Inc. (WMT)'s Peter Lynch chart by clicking Interactive Chart, choosing “Peter Lynch Chart” under “User Defined Chart” on the left corner above the chart.

In my last research Earnings, Free Cash Flow, Book Value? Which Parameters Are Stock Prices Most Correlated To?, we find out that stock price performances are more correlated to book value per share, EBITDA per share and operating income per share over long term. After doing that, it makes me think which stocks' prices are most correlated to book value per share, earnings per share, sales per share, EBITDA per share and operating income per share. If, for instance, one stock’s price is highly correlated to book value, then similar to what did Peter Lynch did, we can generate a new chart which may serve better than the Peter Lynch chart to value this stock.

Furthermore, if the price of a stock is closely correlated to its earnings, book value or sales, the chances are it will continue to be closely correlated in the future. In this way, we can screen for the stocks that have historically had close correlations with earnings, book value or sales, and they are now traded at below their Earnings Line, Book Value Line, or Sales Lines. In the case of Earnings Line, we can screen for the stocks that Peter Lynch referred to as “the stock price fell well below the earnings line,” and we will probably “do pretty well.”

Methodology

In statistics, the coefficient of determination, denoted R squared, indicates how well data points fit a line or curve. In our case, we use the linear regression. I use quarterly data (some companies reported semiannually which we use semiannual data) to do regression of stock price and business performance parameters for the recent 10 years and then find which parameters are most correlated to stock price. These parameters include book value per share, earnings per share, revenue per share, EBITDA per share and operating income per share. Using programming, I ran the R squared for all the stocks which have at least 10-year history with complete data. The higher the R squared, the better the stock price is correlated to those business performance parameters. During the research, I use median P/B, P/E, P/S, P/EBITDA and P/Operating Income to project the stock prices. In this way, when the stock price line is lower than the projected price line, or I should call them book value line and so forth, the stock is considered undervalued.

Results

Using programming, I get five lists of stocks which are highly correlated to each of those business performance parameters among the more than 60,000 stocks that we cover with GuruFocus Global Membership.

Book Value Per Share

Table 1: Book Value Per Share
TickerExchangeR Squared
FSCLSE0.9912
IATLSE0.9897
JFJLSE0.9894
MNKSLSE0.9893
JPSLSE0.9878
MTULSE0.9858
FCSLSE0.9844
ABDLSE0.9822
FRCLLSE0.9791
PLBTSX0.9697
EUTLSE0.9684
CGTLSE0.9665
MBINYSE0.9621
JCHLSE0.9619
SHRSLSE0.9611
PRGONYSE0.9593
AGIINAS0.9565
CMGTSX0.9553
AZONYSE0.9545
DRLNYSE0.9529
1. Invesco Asia Trust PLC (LSE:IAT) (R Squared = 0.9897)

1380567893195.png

2. Aberdeen New Dawn Investment Trust PLC (LSE:ABD) (R Squared = 0.9822)

1380567840326.png

3. MBIA Inc. (NYSE:MBI) (R Squared = 0.9621)

1380567774916.png

From above three charts, we can observe that the projected prices using median P/B ratio time book value each quarter are highly correlated with the real quarterly ending stock prices. Now the stock price line is lower than the so-called book value line which means these stocks might be undervalued.

Earnings Per Share

Table 2: Earnings Per Share
TickerExchangeR Squared
AZONYSE0.9795
ORLYNAS0.9705
EXPONAS0.9703
SHOONAS0.9533
NEOGNAS0.9468
BCPCNAS0.9440
ATRINAS0.9426
TSCONAS0.9421
GLNTSX0.9372
ROSTNAS0.9370
MULLSE0.9366
HCSGNAS0.9352
MRMASX0.9347
TJXNYSE0.9329
ROLNYSE0.9325
DLTRNAS0.9322
AAPLNAS0.9312
BAPNYSE0.9281
DORMNAS0.9255
CERNNAS0.9245
1. Glentel Inc (TSX:GLN) (R Squared = 0.9372)

1380569369201.png

2. Mulberry Group PLC (LSE:MUL) (R Squared = 0.9366)

1380569552896.png

3. Mermaid Marine Australia Limited (ASX:MRM) (R Squared = 0.9347)

1380569795570.png

The above three stocks are highly correlated with the earnings line (median P/E ratio times annually earnings) and the price line is lower than the earnings line now.

Sales Per Share

Table 3: Sales Per Share
TickerExchangeR Squared
MCDNYSE0.9736
AZONYSE0.9701
CCTTSX0.9575
AMZNNAS0.9490
NEOGNAS0.9469
SRCLNAS0.9462
DTVNAS0.9397
DOMLSE0.9360
PRGONYSE0.9320
PCLNNAS0.9311
ATRINAS0.9295
CNQRNAS0.9287
ITRKLSE0.9266
CALMNAS0.9207
BWLDNAS0.9160
EXPONAS0.9153
DBKXTER0.9152
AVHINAS0.9125
LKQNAS0.9099
ALXNNAS0.9043
1. Amazon.com Inc. (NAS:AMZN) (R Squared = 0.9490)

1380571797546.png

2. Directv (NAS:DTV) (R Squared = 0.9397)

1380571879700.png

3. Deutsche Bank AG (XTER:DBK) (R Squared = 0.9152)

1380572004255.png

The above three stocks’ quarterly ending prices are highly correlated with the sales line (median P/S ratio times annually sales) and the price line is lower than the sales line.

EBITDA Per Share & Operating Income Per Share

Table 4: EBITDA Per ShareTable 5: Operating Income Per Share
TickerExchangeR SquaredTickerExchangeR Squared
AZONYSE0.9762AZONYSE0.9780
SHOONAS0.9577ORLYNAS0.9617
EXPONAS0.9550SHOONAS0.9581
ULTINAS0.9464EXPONAS0.9516
WCNNYSE0.9453DLTRNAS0.9460
NEOGNAS0.9441CCTTSX0.9460
PCLNNAS0.9439NEOGNAS0.9440
CASYNAS0.9428PCLNNAS0.9439
DLTRNAS0.9390BCPCNAS0.9429
CCTTSX0.9388TSCONAS0.9412
DTVNAS0.9387MULLSE0.9380
ORLYNAS0.9384TJXNYSE0.9368
ATRINAS0.9337ATRINAS0.9344
TJXNYSE0.9325ROLNYSE0.9329
DDSNYSE0.9293AAPLNAS0.9324
BCPCNAS0.9288ROSTNAS0.9315
SRCLNAS0.9281AIRMNAS0.9258
MULLSE0.9268CERNNAS0.9241
ROSTNAS0.9237SRCLNAS0.9233
BACNYSE0.9226WCNNYSE0.9232


The above two tables are the list of top 20 companies whose projected quarterly prices are highly correlated with the quarterly ending trading prices.

Conclusion

For the companies that have enough history, around 5% of them have R squared bigger than 80%, another 5% have R squared ranged from 70% to 80%, and 10% of them have R squared from 60% to 70%. From above research, we can see different stocks might be highly correlated with different business performance parameters. For those highly correlated stocks with one of the business performance parameters, we can draw their performance parameter line using the stocks’ interactive chart, just like what did Peter Lynch did, to value the stocks.

For the next step, we will create a screener for the stocks whose prices have the highest correlation with the earnings, book value or sales, and their current prices are “well below” the Earnings Line, Book Value Line or Sales Line. Combined with requirement on the companies’ financial strength and growth, this can serve as the Peter Lynch Screener. Stay tuned.

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Rating: 3.1/5 (8 votes)

Comments

max profit
Max profit - 1 year ago


Are you still pursuing this?

thanks
gurufocus
Gurufocus premium member - 1 year ago
hi Max profit,

yes, we are. We developed a screen, it is here: _http://www.gurufocus.com/Peter_Lynch_Stocks.php

We are not satisfied with it. So it is not published.
goforit
Goforit premium member - 10 months ago

What’s the advantage of generating a Peter Lynch Chart (plotting stock price and scaled earnings over time) verses simply plotting a single curve for the PE ratio to see whether a stock is mispriced? In fact, isn’t a plot of PE10 (Shiller PE) even better, since it helps compensate for possible cyclical variations in earnings, as well as non-recurring expenses/earnings?

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