Reading time: 2 minutes
When I started my investing journey over a decade ago, the first investing book I read was One up on Wall Street, written by one of the world’s most successful investors – Peter Lynch, who ran Fidelity’s Magellan Fund. For those new to investing, I highly recommend picking up a copy, as it is extremely accessible for non-finance types and could help you with your investments in the future.
When Lynch took over the fund in 1977, Fidelity’s fund had about US$18 million in funds under management. It had grown to be the largest fund in the U.S. at the time with over US$14 billion when he retired in 19901. His return over the 13 years was an amazing 29% p.a., or a total return of over 2,700% – $100,000 invested in the fund would have been worth close to $3 million by the time he’d finished working his magic.
Among the general advice Lynch offers to investors in One up on Wall Street are the following guidelines:
1. Don’t try to time the market – think long term
“Absent a lot of surprises, stocks are relatively predictable over 10-20 years. As to whether they’re going to be higher or lower in two to three years, you may as well flip a coin to decide.”
“The key to making money in stocks is not to get scared out of them.”
“Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.”
Lynch believed that investors are far better served dollar cost averaging and buying more of a stock (or an ETF) when markets fall.
2. Invest in what you know
“Never invest in any idea you can’t illustrate with a crayon.”
“The basic story remains simple and never-ending. Stocks aren’t lottery tickets. There’s a company attached to every share.”
“The simpler it is, the better I like it.”
This is arguably the most famous of Lynch’s lessons, and something all investors can do – invest in things we are familiar with. As consumers of products and services, we can all test out foods, cosmetics, electronics, branded goods and various services in our day to day lives.
3. The importance of the PEG ratio
As well as these general guidelines, Lynch was also famous for popularising the PEG ratio, or price/earnings to growth ratio.
The formula is:
PEG ratio = P/E ratio / company’s earnings growth rate
Lynch used the PEG ratio to try solving a perceived shortcoming of the P/E ratio by factoring in the projected growth rate of future earnings.
According to this approach, if, for example, two companies are trading at 20x earnings, and the earnings of one of them is growing at 10% but the other at 25%, the latter represents a better buy with a higher probability of making a higher return.
Proponents of this theory argue that the faster the company is growing, the higher the P/E ratio you should be willing to pay – there’s no need to be scared of ‘expensive’ stocks if they have the earnings growth rates to support the valuation.
To interpret the ratio, a result of 1 or lower says the stock is either at par or undervalued based on its growth rate. If the ratio results in a number above 1, conventional wisdom says the stock is overvalued relative to its growth rate.
In saying that, however, it is extremely hard to find stocks with PEGs of 1 or less, so when assessing the merits of an investment on this metric alone, the closer to 1 the better.
While getting this data can be hard at times, applying it to ETFs throws out some interesting results.
Example 1 – Australian equities
The BetaShares Australian Ex-20 Portfolio Diversifier ETF (EX20) provides exposure to a portfolio of the 180 largest companies on the Australian sharemarket outside the top 20.
The table below sets out, for EX20 and for the broad Australian sharemarket, as represented by the S&P/ASX 200 Index:
- EPS growth (forward estimate)
- Forward P/E
- PEG Ratio
- 12-month forecast dividend yield
Based solely on the PEG ratio, EX20 arguably provides a better value option than the broad Australian market, despite having a slightly higher forward P/E ratio.
|Description||S&P/ASX 200 Index||EX20 Index|
|EPS Growth (Forward Est)||9.46%||14.38%|
|12-month forecast dividend yield||3.26%||3.10%|
Source: Bloomberg, as at 23 October 2020. All figures are calculated at an aggregated index level. EPS Growth is based on growth between Bloomberg consensus earnings one and two years forward. Forward P/E uses one year forward Bloomberg consensus earnings. Yield will vary and may be lower at time of investment. Future results are inherently uncertain and actual outcomes may differ.
Example 2 – International equities
Looking at international equities, we can see that the BetaShares FTSE 100 ETF (F100) appears extremely cheap relative to some other markets, based on the PEG ratio – no surprise given its heavy weightings to energy stocks and financials, two sectors that have been hardest hit during the pandemic.
The table below provides figures for F100, and also:
- The broad U.S. sharemarket (as represented by the S&P 500 Index)
- the Betashares NASDAQ 100 ETF (NDQ)
- the BetaShares Asia Technology Tigers ETF (ASIA)
Interestingly, despite its impressive run over the last decade, the Nasdaq 100 (which NDQ aims to track) still appears cheaper than the ASX 200 using the PEG ratio as a metric – despite outperforming the ASX 200 by almost 400% over that period2! Australian investors who are overweight Australian equities may wish to consider international exposures such as those listed below, both on valuation grounds, and to provide portfolio diversification.
|EPS Growth (Forward Est)||22.42%||31.03%||15.50%||46.60%|
Source: BetaShares calculations as at 12 November 2020. All figures are calculated at an aggregated index level EPS Growth is based on growth between Bloomberg consensus earnings one and two years forward. Forward P/E uses one year forward Bloomberg consensus earnings. Yield will vary and may be lower at time of investment. Future results are inherently uncertain and actual outcomes may differ.
While investment decisions should not be based solely on a single financial metric, the PEG ratio is worth a look, as it reflects not just the price of a stock or ETF relative to its earnings, but also the projected growth rate of those earnings.
Investing involves risk. The value of an investment and income distributions can go down as well as up. Before making an investment decision you should consider the relevant Product Disclosure Statement (available at www.betashares.com.au) and your particular circumstances, including your tolerance for risk, and obtain financial advice. An investment in any BetaShares Fund should only be considered as a component of a broader portfolio.
1. Fidelity Viewpoints. “Peter Lynch: Secrets to Success | Investing Lessons | Fidelity.” Fidelity, Fidelity Viewpoints, 18 Sep 2019, www.fidelity.com/viewpoints/investing-ideas/peter-lynch-investment-strategy.
2. Source: Bloomberg. As at 30 October 2020. Past performance is not indicative of future performance of the index or ETF. Does not take into account ETF fees and costs. You cannot invest directly in an index.