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Eight steady growth shares

My Peter Lynch Stalwarts stock screen has generated a 65 per cent total return over the past three years. Eight steady growth stocks have passed all the screen's tests this year.
May 12, 2015

Since I started running my screen based on the 'Stalwarts' strategy advocated by famed US fund manager Peter Lynch the results have been decidedly mixed. My description of the performance as "mixed" is more than just a euphemism for a terrible 2014. Indeed, while over the past year the screen substantially underperformed the 10.3 per cent total return from the FTSE All-Share with a negative 10.4 per cent, but this poor run followed a truly tremendous 2013 screen that produced a 63.6 per cent total return, compared with 12 per cent from the market.

YearPeter Lynch Stalwarts Total ReturnFTSE All-Share Total Return
201212.4%16.7%
201363.6%12.0%
2014-10.4%10.3%

Source: Thomson Datastream

 

The screen's cumulative total return since I started running it in April 2012 now stands at 64.7 per cent, or 57.4 per cent if a 1.5 per cent charge is factored in to account for dealing costs, compared with 44.2 per cent from the All-Share. In fact, if one was not aware of the rollercoaster ride the screen has been on to generate this performance (see graph), it would be tempting to conclude that the screen was achieving the kind of modest outperformance one would associate with a strategy that's designed to highlight slow-and-steady growth stocks.

 

Lynch Stalwarts vs FTSE All-Share

Source: Thomson Datastream

 

The Peter Lynch Stalwarts screen looks for stocks that boast solid but unexciting levels of growth, and whose shares undervalue that growth. The kind of company that fits the bill should, in theory, be the kind of dull business that the market often tends to overlook and undervalue. Unfortunately, last year many of these stocks belonged to companies that had their fortunes linked to the oil price and events in Russia (see table below). As the oil price plummeted, these shares headed south.

 

NameTIDMTotal return (29 Apr 2014 - 8 May 2015)
Travis PerkinsTPK26.7%
easyJetEZJ17.2%
InterserveIRV0.8%
KingfisherKGF-6.4%
Bank of GeorgiaBGEO-26.8%
PetrofacPFC-38.3%
Premier OilPMO-46.3%
Average--10.4%
FTSE All-Share-10.3%

Source: Thomson Datastream

 

While my screen concentrates on the quantitative side of Mr Lynch's stockpicking process, he was a strong advocate of investors undertaking significant research in addition to finding stocks boasting impressive numbers. Much of his advice to investors in his famed 1989 book One Up On Wall Street has a homely feel. As well as liking dull businesses with boring names in unglamorous and easily-over-looked parts of the market, he became well known for his "buy-what-you-know" philosophy. The emphasis he put on the advantage to investors of having experience of a company and its products can be overstated, but he did believe first-hand experience could give private investors a definite edge over the professionals.

Much of Mr Lynch's screening criteria has a commonsense feel to it. That includes his key valuation criteria, which is a price-earnings growth (PEG) ratio adjusted for dividends - he viewed dividends as a very important factor in generating strong returns from stocks showing low and moderate levels of growth. My screen calculates the Lynch PEG ratio as follows:

Price-earnings (PE) ratio/Forecast EPS growth for the next two financial years + historic dividend yield (DY)

NB EPS growth plus the dividend yield is often referred to as a stock's total return. This should not be confused with the total return used to measure an investment's performance, which is based on the share price movement plus dividends received

 

The full screening criteria are:

■ A dividend-adjusted PEG ratio of less than one.

■ Average forecast earnings growth over the next two financial years of between 10 per cent and 20 per cent as long as forecast growth in each of the next two financial years is positive but below 30 per cent.

■ Gearing of less than 75 per cent, or in the case of financial companies (where taking on large slugs of debt is part of their business), equity to assets of 5 per cent or more, and a return on assets of more than 1 per cent.

■ Three years of positive earnings.

■ Turnover of over £250m (Mr Lynch actually sets a far larger dollar-denominated minimum turnover size limit for his stocks of $2bn).

Eight stocks passed all the Stalwarts tests. They are listed below from lowest to highest dividend-adjusted PEG.