Following Buffett and Graham, the third investor I read about early in my investing career was Peter Lynch, famous for his book “One Up On Wall Street“. Peter Lynch definitely deserves a place in the Guru hall of fame with his averaged returns of 29% per year during the 13 years he ran the Fidelity Magellan Fund from 1977 to 1990.
Lynch is much more of a value investor than Martin Zweig or James O’Shaughnessy, but still falls into the growth camp. He popularized the term GARP (Growth at A Reasonable Price) where the PEG ratio serves as the benchmark to determine whether a stock is undervalued.
5 Quick Tips from Peter Lynch
Although Peter Lynch looked for growth, his investing philosophy sounds a lot like Warren Buffett's. Here are some tips from Peter Lynch.
1. Know What You Own
Your investor’s edge is not something you get from Wall Street experts. It’s something you already have. You can outperform the experts if you use your edge by investing in companies or industries you already understand.
Never invest in any idea you can’t illustrate with a crayon.
2. Don’t Bother Trying to Predict the Markets
You get recessions, you have stock market declines. If you don’t understand that’s going to happen, then you’re not ready, you won’t do well in the markets.
3. Behind Every Stock is a Company
I think you have to learn that there’s a company behind every stock, and that there’s only one real reason why stocks go up. Companies go from doing poorly to doing well or small companies grow to large companies.
Although it’s easy to forget sometimes, a share is not a lottery ticket… it’s part-ownership of a business.
4. Invest in Quality Companies
Go for a business that any idiot can run – because sooner or later, any idiot probably is going to run it.
5. You Will Lose Money. Just Don’t be an Idiot.
There’s no shame in losing money on a stock. Everybody does it. What is shameful is to hold on to a stock, or, worse, to buy more of it, when the fundamentals are deteriorating.
GARP Investment Strategy Checklist
Lynch lays out excellent stock selection criteria in his book “One Up On Wall Street“. Let’s see whether Dolby Laboratories (NYSE:DLB) offers any value.
- Select one of the six classifications of the investment.
DLB is considered to be a fast grower.
PEG Ratio – [PASS]
- PE for DLB is 26.46 and growth rate is 31.55% based on the average of the 3,4 and 5 year historical growth rates.
PEG for DLB is 0.84 which is less than 1.
Sales and PE Ratio – [PASS]
- If sales are greater than $1 billion, the PE should be below 40 as large companies may not be able to support growth higher than a PE of 40.
DLB sales is just under $1 billion at $922.7M and the PE is 26.46.
EPS Growth Rate – [PASS]
- EPS growth range should be between 20% and 50%. Anything above 50% is unlikely to be sustainable.
EPS growth for DLB is 31.6% which satisfies the criteria.
Total Debt/Equity Ratio – [PASS]
- above 80% is considered high
- above 60% is mediocre and other statistics must be good
- below 50% is acceptable
- below 20% is great
DLB has ZERO debt. Superb.
FCF Yield – [NA]
This is a bonus and not a requirement.
- If the FCF yield (FCF/Price) is above 20% then it is a huge bonus and a sign that the company is very cheap.
DLB’s current FCF yield is 3.85%, which isn’t that much greater than a risk free rate if you add the premium required for stocks.
Net Cash to Price Ratio – [NA]
Another bonus criteria.
- Net Cash = Cash and Marketable Securities – Long Term Debt
Net Cash/Price for DLB is 11.45% which is considered too low.
Dolby is Growth at A Reasonable Price
DLB is not cheap. It is reasonable. But if you consider the industry it is in and dive in to understand the business model, it is no wonder the company has been doing so well.