Peter Lynch Chart Shows Berkshire Holding DaVita Overvalued

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May 29, 2013
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The new investment managers of Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial), Ted Weschler and Todd Combs, have generated great performance numbers since they join Berkshire. One of the reasons is that they bought into dialysis service provider DaVita. The stock of DaVita has had a tremendous run over the past four years. It gained 53% alone over the past 12 months.

If you wonder why Berkshire Managers like DaVita, please read Geoff Gannon’s article Why Ted Weschler Keeps Buying DaVita (DVA, Financial).

Ted Weschler started buying DaVita in 2011. Berkshire now owns almost 14 million shares, or 14.2% of the company. The last purchase by Berkshire Hathaway was on March 4, 2013, as reported in GuruFocus Real Time Picks.

While the stock has had great run, it may have gone ahead of itself, as suggested by DaVita’s Peter Lynch chart below:


Peter Lynch said in his book One Up on Wall Street, “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.”

Just as pointed out by Peter Lynch and shown in the chart above, the stock prices of DaVita closely follow the Earnings line in Peter Lynch Chart. When the price was above the Earnings line, it always tended to deliver poor returns. When the price was below the Earnings line, it tended to perform better in the following years. As of today, the price is above the Earnings line by almost 100%. We do not expect good returns from DaVita in the coming years.

By the way, you can learn how to create a Peter Lynch Chart in two clicks here.

GuruFocus DCF Calculator and Reverse DCF Calculator further proves that the stock is overvalued. At 13.3% earnings growth rate for the 10 years and 12% discount rate, the fair value of the stock is $77.4, suggesting the stock is 61% overvalued. A lower 10% discount rate suggests the stock is 35% overvalued. Again at 10% discount rate, Reverse DCF suggests that the company needs to grow its earnings 17.72% for the next 10 years.


How realistic is it for DaVita to grow its earnings at 17.72% for the next 10 years? Let’s look at its past growth. In the past five years, the company grew its revenue and net income at about 9% a year. See the chart below:


The company has been buying back shares at about 2% a year. Therefore its earnings per share has been growing at about 11% a year. The market expectation of 17.7% a year as derived from Reverse DCF Calculator seems out of reach.

Check out DaVita 10-year financial data and charts.

Disclosure: The author does not own shares of DVA.