Validea's Guru Spotlight: Peter Lynch

02/04/2015 9:00 am EST


John Reese

Founder and CEO, And Validea Capital Management

Choosing the greatest fund manager of all-time is a tough task. But if you were to rank Peter Lynch at the top of the list, you'd probably find few would disagree, asserts John Reese, editor of Validea.

During his 13-year tenure as the head of Fidelity Magellan, Lynch produced a 29.2% average annual return, nearly twice the 15.8% return that the S&P 500 posted during the same period.

If you'd invested $10,000 in Magellan the day Lynch took the helm, you would have had $280,000 when he retired 13 years later.

Interestingly, a big part of his approach involved something that is not at all exclusive to being a renowned professional fund manager: He invested in what he knew.

Lynch believed that if you personally know something positive about a stock—you buy the company's products, like its marketing, etc.—you can get a beat on successful businesses before professional investors get around to them.

The most important fundamental he looked at was one whose use he pioneered: the PEG ratio, which divides a stock's price/earnings ratio by its historical growth rate.

He also looked at the inventory/sales ratio, which my Lynch-based model wants to be declining and the debt/equity ratio.

The final part of the Lynch strategy includes two bonus categories: free cash flow/price ratio and net cash/price ratio. Lynch loved it when a stock had a free cash flow/price ratio greater than 35% or a net cash/price ratio over 30%.

Over the long-term, my Lynch-inspired model has had its ups and downs, but if you've stuck with it, it's paid off.

Overall, since I started tracking it in July 2003, the portfolio has averaged annualized returns of 10.9%, easily beating the 6.6% annualized return for the S&P 500.

Here's a look at the stocks that recently made up my Lynch-based portfolio:

Silicon Motion Technology Corporation (SIMO)
IDT Corporation (IDT)
FutureFuel (FF)
HCI Group (HCI)
WSFS Financial Corporation (WSFS)
New Oriental Education & Technology Group (EDU)
TriCo Bancshares (TCBK)
SLM Corporation (SLM)
Regional Management Corp. (RM)
Amtrust Financial Services (AFSI)

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