In "One Up on Wall Street," super investor Peter Lynch detailed a few of the techniques he used to find winning stocks. His goal, he often said, was to find "ten-baggers," stocks which he would hold for years and end up selling for at least 10 times the amount he paid for them.
Lynch made his name running Fidelity Investments flagship Fidelity Magellan Fund from May 1977 to May 1990. During that run, Lynch racked up an astounding 29 percent annual return.
His strategy was later codified as "Buy What You Know," a philosophy he shares with Warren Buffett. Put simply, if you don't understand what the company does, stay away from the stock.
Lynch liked to find undervalued stocks with above-average earnings growth, strong financials, and low institutional ownership. The specific criteria are:
• The P/E ratio should be below the industry average, and also below the stock’s own five-year average.
• Earnings per share must be increasing faster than the average stock over the past five years.
• The ratio of liabilities to assets needs to be less than the industry average.
• Institutional ownership should be less than average. This means when the institutions discover the stock, there should be large gains for investors who were in early.
• We also excluded stocks in the financial or real estate operations sector since there are potential problems in those areas right now.
Based upon recent research by Winans International, I limited the screen to mid-cap stocks. In what may be the first comprehensive study of these stocks, Winans found that, through 2007, this asset class would have more than doubled the long-term returns available through small cap or large cap stocks.
When looking for long-term winners like Lynch did, it makes sense to closely examine this sector.
Out of almost 9,000 potential stocks, just nine passed the Peter Lynch "ten-bagger" screen.
Adams Golf (ADGF) This company makes the Idea hybrid club, which the company says combines the best of woods and irons, making it much easier to hit the ball. At a recent price of 6.50, ADGF trades at 0.44 times sales and 0.76 times book value.
Birner Dental Management Services (BDMS) BDMS manages 60 dental practices. Its 4 percent dividend yield is well covered by cash flow. This is a thinly traded, little known stock with solid profitability. Recently priced at 16.95, but because it is thinly traded limit orders should be used for any buys.
Champion Industries (CHMP) This mini-conglomerate is involved in the printing business, office supplies, office furniture, and newspapers. The company is profitable, but difficult to understand. That means management could one day do a spinoff, which can add value for shareholders. In the meantime, CHMP was recently trading near 4.87 a share, paying patient investors a dividend yield of 4.8 percent.
CKX Lands (CKX) CKX is an oil and gas royalty company that owns 10,375 acres in Louisiana. The land is carried on their balance sheet at $227 an acre, although recent sales of similar properties have been for as much as $19,000 an acre. This undervalued company recently traded at 13 and could be worth much more as the land value is recognized by the market.
Continucare (CNU) Rated a Strong Buy by Thompson, CNU is expected to enjoy earnings growth of 20 percent a year for the next five years. The company manages doctors’ offices in Florida. From the recent price level of 2.30, analysts think this stock can double over the next 12 months.
Daily Journal (DJCO) A publisher of legal newspapers, magazines, and Web sites in California, Arizona, and Nevada, DJCO trades at 41.50, with a P/E ratio under nine. No analysts follow the company, but the largest shareholder is the very successful Weitz Value Fund.
Espey Manufacturing & Electronics (ESP) ESP supplies power system components to defense contractors. The company is debt free, has a P/E ratio of 14 and dividend yield of 3.5 percent. Recent price: 22.16.
iBasis (IBAS) Selling more than $1 billion in prepaid phone cards a year has delivered healthy bottom-line profits for IBAS. Insiders have been adding to their holdings near the recent price of 3.47. Insider buying is usually a sign that management thinks the company is undervalued.
Monarch Cement (MCEM) This small company has a long history of profitability and steady dividends. As one of the smallest companies in its industry, it may be a takeover target, offering extra upside. Recently trading near 28, MCEM has a P/E ratio of eight and a yield of 3.3 percent.
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