Extracting Ideas From Two Legendary Investors

 | Mar 31, 2013 | 4:00 PM EDT  | Comments
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Peter Lynch is a legendary investor who, in the 1980s, built the Fidelity Magellan fund into the largest mutual of funds in the world. Warren Buffett is widely thought of as one of today's greatest investors -- maybe the greatest investor alive right now.

I don't know if Lynch and Buffett have ever met in person; but, through my "guru" stock screens, I have orchestrated a virtual meeting of the minds as I've determined which stocks currently earn high grades from both my Lynch and Buffett strategies. I developed these strategies years ago by computerizing the investment approaches of a number of great Wall Street investors.

First, let's go over these particular strategies. The most significant variable in the Lynch screen is the P/E/G ratio, or price-to-earnings relative to growth, which measures how much the investor is paying for growth. A P/E/G of 1.0 means the investor is paying $1 for every 1 percentage point of growth, and 1.0 is the upper limit set by the strategy; the lower the better, generally, as this points to a good deal relative to the company's growth rate. The Lynch strategy looks at other variables, as well -- such as total debt-to-equity ratio for non-financial companies, and the equity-to-assets ratio for financial names.

The Buffett strategy is very different. It likes companies that are among the top members of their industry. It then looks at a number of other variables, such as stable earnings growth, at least a 15% average return on equity and a 12% minimum average return on total capital. Finally, the strategy prefers to see at least a 15% likely annual rate of return over the next 10 years from the current stock price -- which it calculates by taking the average of two different estimates to that effect.

One stock that garnered high marks from both strategies is Syntel (SYNT), which sells information-technology consulting and outsourcing services for software development, maintenance and management. It has 30-plus years of history, so the company is well established in its market.

The Buffett strategy wants a company with a durable competitive advantage, and Syntel's history and global reach give it such an advantage. Also in its favor is a fairly predictable earnings-per-share history, a lack of debt and a solid 28.6% return on equity over the last 10 years. In addition, the dual-pronged calculation of the likely 10-year return points to a 17.1% average per year, which is excellent. As for the Lynch strategy, Syntel's P/E/G comes to 0.76, providing a strong reason to buy.

Tractor Supply (TSCO) is another stock that's won the investor equivalent of a doubleheader. The company, a big player in rural America, operates more than 1,176 farm and ranch retail stores in 45 states. The company earns a P/E/G of 0.95, just under the Lynch strategy's maximum of 1.0, and it has the very low debt level that the Lynch strategy likes. The Buffett strategy favors Tractor Supply because of the company's significant market position, its rising earnings in each of the last 10 years, its low debt and its 12.1% projected annual return to investors over the coming decade.

A very different type of retailer, but also a stock that gets high grades from both my Lynch and Buffett strategies, is TJX (TJX). The company operates T.J. Maxx, Marshalls and other off-price retailers, with more than 2,900 stores in six countries. My Buffett strategy likes T.J. Maxx because it is dominant in its market niche, has consistently increasing earnings per share, moderate debt and a projected annual return of 17.6%. The Lynch strategy likes the company's 0.77 P/E/G and low debt.

So, here we have it: two guru strategies and three companies. In the case of Lynch and Buffett, that's a winning combination.

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