Peter Lynch is a legendary investor and fund manager of his time. He is well known for managing the Megallan Fund at Fidelity Investments from 1977 till 1991. While his time managing the fund, he averaged around Twenty Nine percent annual return. Peter Lynch was a “Story” investor. He believed that each company has its own story, and he loved great stories. Peter Lynch’s approach to finding stocks was very simple. In today’s newsletter, let us explore how Peter Lynch approached investing and stock selection.

The “Story” approach to stock selection

In modern terms, Peter Lynch is a growth investor who blended value investing in his approach. He always looked for companies that had the potential to grow and were mostly ignored by the institutions on the Wall-street. He was searching for companies that could grow their profits and sales exponentially.

Peter Lynch believed a company could improve its earnings in 5 ways:

1. Reducing its costs

2. Raising the price of its products or services

3. Expand into newer markets

4. Sell more products in the existing market

5. Shut down inefficient operations

For Lynch, companies that could grow its earning, the bottom line of the company, were the attractive candidates. Any one of the above sources of improved growth sparked Lynch’s interests.

Peter Lynch had 7 criteria for stock selection:

1. Annual Earnings growth: To show growth and stability

2. Annual Earnings growth rate: Should fit with company’s “Story”

3. P/E ratio: This was a metric Peter Lynch used to check for an attractive valuation

4. P/E v/s 5-year average P/E of the company

5. P/E v/s Industry average

6. PEG ratio: Price-to-Earnings Growth rate.

7. Debt-to-Equity ratio: To ensure that the company was not overly leveraged.

A while back, I made a video on the Peter Lynch model where I explain how Lynch categorized various companies and threshold for the above criteria. In the video, I also explain how to build a scanner based on these criteria. Do check out the video 👇👇