Peter Lynch Fair Value, also known as Peter Lynch Fair Value in English, is a calculation model that measures the intrinsic value of a growth company and can be used to evaluate whether the company's stock is overvalued. Peter Lynch fair value, proposed by investment guru Peter Lynch, is the company's price-to-earnings growth rate (PEG) multiplied by the current five-year average earnings per share growth rate (EPS Growth Rate) and multiplied by the earnings per share over the past 12 months (EPS TTM). Investors can determine whether a company's stock is overvalued by comparing the Peter Lynch fair value to the current share price. When Peter Lynch's fair value is less than the current stock price, the company's stock price is considered overvalued, and the larger the difference, the greater the degree of overvaluation; when Peter Lynch's fair value is greater than the current stock price, the stock's price is considered undervalued, and the larger the difference, the greater the degree of underestimation. In actual use, Peter Lynch's fair value is more suitable for evaluating growth companies. For start-ups and emerging companies, there will be a large evaluation bias. Based on the calculation method of Peter Lynch's fair value, its evaluation of stock prices is based on the company's future development speed being the same as its past development speed. Therefore, companies with slower growth will often be underestimated and companies with faster growth will be overestimated. Peter Lynch is one of the most successful mutual fund managers in history and one of the most successful investors. His books "One Up on Wall Street" and "Beating the Street" are among the best-selling investment books. @Amazon Affiliate Link Peter Lynch was born in 1966. After receiving his bachelor's degree from Boston College, he earned his MBA from the Wharton School of the University of Pennsylvania. After entering the field of financial investment, Peter Lynch managed the Magellan Fund from 1977 to 1990. Through his unique investment philosophy, the Magellan Fund achieved an estimated return on investment of nearly 30% during this period, making Peter Lynch famous. During his investment management career, Peter Lynch proposed his own valuation method to evaluate the value of stocks, which is now recognized as Peter Lynch's fair value. How to use Peter Lynch Fair Value? Peter Lynch fair value is calculated by multiplying the company's price-to-earnings growth rate (PEG) by the company's average EPS growth rate over the previous five years times the most recent TTM EPS, which is: Peter Lynch Fair Value = PEG x EPS Growth over the Past 5 Years x EPS over the Past 12 Months Peter Lynch Fair Value = PEG x EPS Growth Rate x EPS TTM Among them: Peter Lynch believes that the price-to-earnings ratio of a growth company should be equal to its earnings per share growth rate, that is, the price-to-earnings growth rate (PEG = 1. Therefore, Peter Lynch Fair Value = EPS Growth Rate x EPS TTM There are a few things to note when using the above formula: When using the earnings per share growth rate to plug into the above formula, please use a value without a percentage. For example, if the earnings per share growth rate is 19%, use 19 to plug into the above formula. Secondly, the earnings per share growth rate should be calculated using the average of the EBITDA per share growth rate in the previous five years. EBITDA here refers to earnings before interest, taxes, depreciation, and amortization, because EBITDA is more difficult to be artificially tampered with than other earnings indicators, and can avoid the impact of some contingency events on the company's earnings. At the same time, for earnings per share growth rates below 5%, the value is too small to reflect the company's growth, so Peter Lynch's fair value cannot be used to evaluate its stock price. For companies with earnings per share growth rates greater than 20%, 20 is more appropriate; EBITDA is calculated by adding the company's net income, interest, taxes, and depreciation and amortization, which is: EBITDA = Net Income + Taxes + Interest Expense + Depreciation and Amortization
EBITDA = Net Income + Taxes + Interest Expense + Depreciation & Amortization Net income, taxes, and shares outstanding can be found in the company's income statement (Statements of Operations); Depreciation and amortization and interest expenses can be found in the Statement of Cash Flows; Earnings per share should also be calculated by dividing EBITDA by the number of diluted shares outstanding. How to Calculate Apple's Peter Lynch Fair Value? This chapter will perform example calculations by using Apple's 10-K financial report released in September 2021: Available from AAPL’s past 10-K financial reports: Find the data from 2016 to 2018: Find the data from 2019 to 2021: Note that Apple adopted a 1 x 4 stock split (Stock Split) in 2020, which means splitting the original 1 share into 4 subsequent shares. The number of shares issued in the table below has been converted to the post-split value. Net income for the year (Millions) Interest (Millions) Taxes (Millions) Depreciation and amortization (Millions) EBITDA (Millions) Number of shares issued EBITTA Earnings per share Earnings per share growth rate 2016 $45,687 $1,316 $1,456 $10,505 $58,964 22,001,124K $2.68 2017 $48,351 $2,092 $2,323 $10,157 $62,923 21,006,768K $2.995 11.75% 2018 $59,531 $3,022 $3,240 $10,903 $76,696 20,000,435K $3.835 28% 2019 $55,256 $3,423 $3,576 $12,547 $74,802 18,595,651K $4.023 4.9% 2020 $57,411 $3,002 $2,873 $11,056 $74,342 17,528,214K $4.241 5.1% 2021 $94,680 $2,687 $2,645 $11,284 $111,296 16,701,272K $6.664 57% average 21.35% Apple’s latest share price, available from AAPL’s investment portal, is $137.59 So, = 1 x 21.35 x $6.664 = $142.28 That is, Apple's current Peter Lynch fair value is $142.28. Compared with the current stock price of $137.59, the stock price is slightly undervalued. What investment guidance does Peter Lynch’s fair value have? First of all, Peter Lynch's fair value is suitable for growth-oriented companies, that is, the company's average earnings per share growth rate is about 10% to 20%. When it exceeds this range, using Peter Lynch's fair value to evaluate the company's stock price will cause serious deviations. When using Peter Lynch Fair Value to assess an appropriate company share price: Peter Lynch’s Fair Value and Stock Price Evaluation Significance Peter Lynch fair value is greater than share price The company's stock price is undervalued Peter Lynch fair value equals share price The company's stock price is relatively fair Peter Lynch fair value is less than share price The company's stock price is overvalued Therefore, for investors, when using Peter Lynch's fair value to evaluate the company's stock price, the higher the Peter Lynch fair value relative to the stock price, the more the company's stock price tends to be undervalued and has good room for growth in the future, which means it is a better investment. What are the limitations of using Peter Lynch's fair value?
When using Peter Lynch's fair value to analyze a slower-growing company, due to its smaller earnings per share growth rate, resulting in a smaller calculated value of Peter Lynch's fair value, the company's stock price will be considered overvalued, but in fact the company's stock may not be overvalued. Therefore, when using Peter Lynch's fair value to evaluate the investment value of a slower-growing company, there may be a bias. Similarly, for companies that are growing faster, the higher the growth rate of earnings per share, the calculated value of Peter Lynch's fair value formula will be larger, and the conclusion is that the company's stock price is undervalued. Investors may make large investments based on this conclusion, but in fact, the company's stock price may not be undervalued. It can be seen that when Peter Lynch's fair value is used to evaluate the investment value of companies that are growing faster, the investment value may be overestimated.