In his excellent book One Up on Wall Street, Peter Lynch, the best
mutual fund manager ever, revealed a powerful charting tool that
helped him to achieve a gain of 29.2% in his portfolios for 13
years. In this chart, Peter Lynch drew the stock price and the
earnings per share together and aligned the value of $1 in earnings
per share to $15 in stock price. He wrote in pages 164-165 of the
"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 when the stock price fell well below the earnings line,
and sold the m when the stock price rose dramatically above it, the
chances are you'd do pretty well."
He also wrote what we now call "Peter Lynch Rule": "If the stock
strays away from the earnings line, soon or later, it will come
back to earnings." (One Up On Wall Street, page 163)
Peter Lynch Rule is clearly at work with Apple, the most valuable
company on the earth. Below is the
Peter Lynch chart of Apple
) from 1998 to 2000:
We can see that
prices have strong correlations with Apple's earnings. Just as
Peter Lynch pointed out, the best times to buy Apple stocks were
when the stock prices dipped below the earnings line, as in the
beginning of 2009 and the middle of 2013.
In order to find the stocks that are traded below their earnings
line, we have developed a
Peter Lynch Below-Earnings-Line Screen
. The screen filters for the stocks that had historically high
correlations between the price lines and the earnings line, but
currently traded at below the Earnings Line.
Median Sales Line
In addition to Earnings Line, this screen can also filters for the
stocks that had historically high correlation between stock prices
and sales, book value, EBITDA etc. For instance, Amazon (
) have always been traded at around 2.1 times of sales over the
past 10 years. Its stock prices are highly correlated with sales,
as shown in the chart below:
Currently Amazon is traded below its historical Sales Line at 2.1
times of sales.
Median Book Value Line
T. Rowe Price (
) has been traded around 5 times of book value over the past two
decades, as show in the chart below. The green price is the stock
price and the blue line is the stock price at 5 times book value.
If TROW were to trade at its historical median of 5 times book
value, the stock price should be around $101 a share. Currently it
is 23% lower.
Premium Subscribers can take a look at the Peter Lynch Screen
here. If you are not a GuruFocus Premium Member, we invite you for
a 7-day Free Trial.
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