By keeping it simple, Lynch allowed his focus to go to the most important task – finding great companies.Once his stellar track record running the Magellan Fund gained the widespread attention that usually follows great performance, Lynch wrote several books outlining his philosophy on investing. The AAII Lynch screen requires that the company have a price-earnings ratio lower than the median for its respective industry.The growth rate of earnings should fit with the firm’s “story” — fast-growers should have higher growth rates than slow-growers. Therefore, after 30 years of the worst possible market timing, the first investor only trailed in his returns by 1.1% per year. He did not focus on the direction of the market, the economy or interest rates. When following up on the initial spark of a great idea, Lynch highlights several fundamental values that he expected to be met for any stock worth buying: This adjustment acknowledges the contribution that dividends make to an investor’s return. It compares the company’s ratio against industry levels because acceptable levels vary from industry to industry. Normal debt levels are higher for industries with high capital requirements and relatively stable earnings such as utilities.You would think that one of the top professional investors who earned his keep by managing other people’s money would try to dissuade individual investors from even trying to pick stocks. Recent stock market volatility reminds us that long-term stock market success requires a certain detachment and tolerance for short-term pain. A price-earnings ratio of half the level of historical earnings growth is considered attractive, while ratios above 2.0 are considered unattractive.For Lynch, a price drop is an opportunity to buy more of a good prospect at cheaper prices. One is rarely certain when making investment decisions, and if one completely understands what is going on, it is already too late to profit. The AAII Lynch strategy requires a lower percentage of shares held by institutions than the median of all U.S.-listed stocks.Lynch refines this measure by adding the dividend yield to earnings growth.
The AAII Lynch screen uses this dividend-adjusted PEG ratio, with a ratio less than or equal to 0.5 specified as a cut-off.AAII has developed a quantitative stock filter, or stock screen, with the goal of identify stocks possessing the fundamental characteristics Lynch looks for when selecting stocks. Also, an investor cannot make a profit if the stock was purchased at a too-high price. In the early 1980s, a young portfolio manager named Peter Lynch … The rotation approach maintains the investor’s long-term commitment to the stock market and keeps the focus on fundamental value.By studying the pattern of price-earnings ratios over several years, you can develop a sense of the normal level for the company. At a minimum, it leads to questions as to why the company is priced differently. Lynch even provided in his bestselling book a list of the most important qualities it takes to succeed: Patience; self-reliance; common sense; tolerance for pain; open-mindedness; detachment; persistence; humility; flexibility; willingness to do independent research; willingness to admit mistakes; ability to ignore general panic and discipline to resist your human nature and your gut feeling.The earnings potential of a company is a primary determinant of company value. Lynch’s ideal investment is a neglected niche company—one that controls a market segment in an unglamorous industry in which it would be difficult and time-consuming for another company to compete. To avoid companies whose earnings growth is not sustainable in the longer term, AAII’s Lynch-inspired strategy excludes companies whose average annual growth rate in earnings per share over the last five years is greater than 50%.Companies with better prospects should sell with higher price-earnings ratios. As Lynch pointed out, stocks will go up and down, and rather than panic when they go down, you must have detachment to stay the course. Peter Lynch: After 50 years of doing this professionally, it reinforces that growth stocks are better than nongrowth stocks. As a result, Lynch believes that trying to predict the short-term fluctuations of the market just isn't worth the effort. This knowledge should help you avoid buying into a stock if the price gets ahead of the earnings or send you an early warning that it may be time to take some profits in a stock you own.