5 Undervalued Stocks Trading Below Peter Lynch Earnings Line

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Jun 05, 2015
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In Peter Lynch’s bestselling book “One Up On Wall Street,” the legendary mutual fund manager wrote that a quick way to tell if a stock is overpriced is to simply compare the stock price with the earnings line.

In the book, Lynch uses a chart to map the price and earnings per share, aligning $1 in earnings with $15 in stock price. The optimal time to purchase a stock is when price falls below the earnings line.

GuruFocus’ Peter Lynch Screen displays companies that have historically had strong correlations between the price and earnings lines and are currently trading below the earnings line. The following are five of these stocks that also have a business predictability rating of 3 stars or higher.

Fossil Group (FOSL, Financial)

Accessories and watchmaker Fossil is currently trading at $72.14 after dropping 32% in the past year. As of March, the Peter Lynch earnings line was at $103.88, suggesting the stock is undervalued.

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Fossil’s P/E ratio is 10.9 and the P/S ratio is 1.1. The business predictability rating is 4 out of 5 stars. Over the past five years, the company has posted good growth rates, with revenue growing by 23.3% and EBIT by 25.2%.

Net income in 2014 was $377 million, on par with the previous year’s income of $378 million. Over the last five years, the figure has grown almost 11%.

Jim Simons (Trades, Portfolio) initiated a new position in the company during Q1, while three gurus including Ray Dalio (Trades, Portfolio), sold out of their holdings.

Alliance Holdings GP LP (AHGP, Financial)

Alliance Holdings’ stock declined 24% in the past year and is now priced at $48.23, with a P/E ratio of 10.6 and P/S ratio of 1.3. As of March, the Peter Lynch earnings line was at $71.10.

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The company’s ARLP partnership is a producer and marketer of coal to U.S. utilities and industrial users. The DCF calculator also estimates the stock is undervalued with a 28% margin of safety, estimating a fair value of $69.62.

The revenue growth rate over the past five years was 12.7%, while EBIT grew by 15.7%. Net income has also steadily increased over time, recording at $284 million in 2014.

The current dividend yield is 7.3% and the payout ratio is 75%. Jim Simons (Trades, Portfolio) was the only guru to trade in Alliance during Q1, more than doubling his stake.

International Business Machines (IBM, Financial)

IBM’s stock declined 10% over the past year, and currently trades at $168.07 with a P/E ratio of 14.5 and P/S ratio of 1.88. Based on the first-quarter earnings, the Peter Lynch earnings line is at $233.30.

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GuruFocus rates IBM’s business predictability as an excellent 4 out of 5 stars. The DCF calculator gives a margin of safety of 45%, with a fair value estimate of $308.07.

Given the company’s already large size, revenue grew by a modest 5% over the past five years, while EBIT grew by 7%.

IBM’s dividend yield is 2.71% — close to the 10-year high. In addition, the payout ratio is just 28%, meaning there’s room to continue growing the dividend.

Leon Cooperman (Trades, Portfolio) and Chase Coleman (Trades, Portfolio) bought new positions in IBM during Q1, while Edward Lampert (Trades, Portfolio), Jim Simons (Trades, Portfolio), and Ronald Muhlenkamp (Trades, Portfolio) sold out of their positions.

Prosperity Bancshares (PB, Financial)

Prosperity Bancshares is a Texas financial holding company for Prosperity Bank, which provides financial products and services to businesses and individuals. The stock is currently priced at $54.49 after declining 7% over the past year.

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The company’s P/E ratio is 12.4, while the P/S ratio is 4.8. The stock is also undervalued according to the DCF calculator, with a 15% margin of safety. The estimated fair price is $65.01.

Revenue grew by 7.7% over the past five years, and EBIT grew by 11.5%. Net income also increased by almost 24% during the same time period, recording at $297.4 million in 2014.

The dividend yield is 1.85%, while the payout ratio is 24%. Four gurus, including David Dreman (Trades, Portfolio) and Joel Greenblatt (Trades, Portfolio), added to their stakes in Prosperity Bancshares during the first quarter.

Copa Holdings (CPA, Financial)

Copa Holdings’ stock declined 38% over the past year and is now priced at $87.77. The Peter Lynch earnings line is at $119.25 based on first-quarter earnings.

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Copa Holdings is a Latin American provider of airline passenger and cargo services. The P/E ratio is 11.6 while the P/S ratio is 1.5. The margin of safety is 56%, with an estimated fair value of $200.64.

The revenue growth rate over the last five years was 17.9%, while the EBIT growth rate was 17.1%.

Copa’s dividend yield is 4.1%, which is close to the 10-year high. The payout ratio is 51%. James Barrow (Trades, Portfolio) added the company as a new holding to his portfolio, while Charles Brandes (Trades, Portfolio) added to his existing stake.

Use the Peter Lynch Screen to find companies trading at prices below their Peter Lynch earnings line. Not a Premium Member of GuruFocus? Try it free for 7 days.