Peter Lynch has been the fund manager of Fidelity Magellan Fund for 13 years, from 1977 to 1990. He popularized the PEG Ratio. During this period, the CAGR of the fund is about 29%. Lynch has invested in hundreds of multi-bagger stocks, including famous names like Taco Bell, Baskin Robbins, Duskin Donuts, Ford Motors, etc.
Lynch is a growth investor who prefers investing in high-growth companies; the wisdom he shares through his books is that a high-growth company to invest in need not necessarily be from a high-growth industry. A high-growth company from a slow-growth industry also can be a multi-bagger.
There are many risks involved in investing in young and fast-growing companies, so we always need to choose companies with a transparent balance sheet & generating sizeable profits.
Once we create a list of companies as potential multi-baggers, to understand the valuation of the companies, Peter Lynch suggests a valuation Method called PEG, which is the ratio of Price to Earnings to Growth.
The Formula for the PEG Ratio is as below
PEG = Price/Earnings/Growth of EPS.
'Price' is the current market price of the stock.
'Earnings' = (Net income – Dividends)/No: of equity shares Outstanding
'Growth of EPS' – CAGR of growth over 3 to 5 years period (Trailing or Forward)
According to Peter Lynch, if PEG is equal to 1, then the stock is fairly valued.
To understand the usage of the PEG ratio clearly, let us give a small illustration.
Consider a stock ABC with a P/E ratio of 10 and a growth rate of EPS at 6%. Then the P/E to Growth (PEG) Ratio of the stock ABC is 1.67% which says that we are paying more for the growth expected in the stock's earnings.
Now consider a stock XYZ with a P/E ratio of 5 and a growth rate of EPS is 10%. Then P/E to Growth (PEG) Ratio of the stock ABC is 0.5% which means you have found a good bargain for yourself in the markets.
PEG Ratio can also be used to compare different companies across the industry and find the best bargains.
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There are a few limitations to PEG Ratio. However, we have prudent methods to in stock picking. For support in creating an investment plan and portfolio management services, please write to us at firstname.lastname@example.org
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