Apple: A Peter Lynch Play?

08/31/2015 7:00 am EST

Focus: STOCKS

John Reese

Founder and CEO, Validea.com And Validea Capital Management

To select his buy-rated stocks, John Reese analyzes the investment strategies of legendary market experts; here, he looks at a stock that earns a buy rating based on the price-earnings to growth strategy of Peter Lynch.

Apple (AAPL) earns a 93% rating on our Peter Lynch model; most importantly, this methodology would consider AAPL a fast grower.

Meanwhile, the investor should also examine the P/E relative to the growth rate (28.92%), based on the average of the 3-, 4-, and 5-year historical EPS growth rates for a company.

This is a quick way of determining the fairness of the price. In this particular case, the price to earnings ratio is 13.3 and the growth rate is 28.92%; this means the PEG ratio for AAPL (0.46) is very favorable.

For companies with sales greater than $1 billion, this methodology likes to see that the P/E ratio remains below 40. Large companies can have a difficult time maintaining a growth high enough to support a P/E above this threshold.

AAPL, whose sales are $224 billion, needs to have a P/E below 40 to pass this criterion. AAPL's P/E of 13.30 is considered acceptable. As such, Apple passes this test.

When inventories increase faster than sales, it is a red flag. However, an increase of up to 5% is considered bearable if all other ratios appear attractive. Inventory to sales for AAPL was 1.03% last year, while for this year it is 1.15%.

Since inventory has been rising, this methodology would not look favorably at the stock but would not completely eliminate it from consideration as the inventory increase (0.12%) is below 5%.

This methodology also favors companies that have several years of fast earnings growth, as these companies have a proven formula for growth that, in many cases, can continue many more years.

This methodology likes to see earnings growth in the range of 20% to 50%, as earnings growth over 50% may be unsustainable. The EPS growth rate for AAPL is 28.9%, based on the average of the 3-, 4-, and 5 year historical EPS growth rates, which is acceptable.

Finally, the Peter Lynch methodology would consider the Debt/Equity ratio for AAPL—currently 43.30%—to be normal; in this case, equity is approximately twice debt.

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