Peter Lynch was one of the most successful investors in modern history. The Fidelity money manager earned a 29.2% annualized return on his Magellan Fund over the 13 years he ran it, from 1977 to 1990, more than doubling the S&P 500 over that time.
That kind of growth rate would have turned $10,000 into more than $275,000 in just 13 years. It's no wonder why Lynch's books One Up on Wall Street and Beating The Street are two of the best-regarded books on investing, and investors continue to follow his playbook nearly 30 years after his retirement.
Lynch had a few core ideas that make his investing philosophy perfect for even a beginner. First, he believed investors should buy stocks they could understand. Lynch often looked for hidden gems in the consumer world, capitalizing on trends he could see before the market caught onto them. Though Lynch researched financial numbers rigorously, he also liked to invest in "story stocks" or companies that have a good story about their future, be it through disruption or industry growth, or some other factor. Finally, Lynch favored a valuation metric he invented, the PEG ratio, which takes the P/E ratio and divides it by the expected EPS growth rate. Unlike the traditional price-to-earnings multiple, the PEG accounts for growth, making it a good tool for finding undervalued growth stocks.
1. Stitch Fix
Personalized styling service Stitch Fix has a lot going for it in the Lynch framework. It's a unique and disruptive stock as a pure play on the fast-growing corner of the clothing sector that sits at the crossroads of e-commerce and customization. Stitch Fix's model eliminates much of the hassle of traditional in-store clothing shopping and online shopping. Using data science, the company gets to know shoppers' sizing and tastes to choose clothing that they like and want to keep.
The growth opportunity for Stitch Fix is also appealing. The U.S. apparel market was estimated to be worth $359 billion in 2018, and both e-commerce and personalization channels are taking up growing percentages of the market. Euromonitor, for instance, expects online apparel sales to grow 14% annually over the next five years. In other words, market share for companies like Stitch Fix should naturally grow as shoppers embrace its model, and the company has forecast long-term revenue growth of 20%-25%, which it has executed on thus far. For fiscal 2020, the company is eyeing 23%-25% top-line growth to nearly $2 billion sales.
Stitch Fix's valuation also looks appealing, as the company is down more than 50% from its all-time high a little more than a year ago and trades at a price-to-sales ratio of a little more than 1 based on this year's expected revenue. The stock is also heavily shorted with 45% of its float sold short, meaning any piece of good news could send the stock flying higher.
Stitch Fix combines a number of promising advantages that Lynch would probably like. It's the leader in the personalized styling service space; its data science algorithm give it an edge over competitors in selecting and developing clothing lines for customers; and it has plenty of growth opportunities, both in new geographies and with new products like Shop Your Looks, a direct-selling model that it just launched, to help it grow over the long term.
2. ANGI Homeservices
Another disruptive e-commerce company, ANGI Homservices is the country's largest online marketplace to get home fixes like cleaning, general contracting, and anything in between. The company is majority-owned by IAC Interactive, the same group behind online dating leader Match Group, and ANGI has many of the same attributes that have helped propel Match Group stock higher in recent years.
Like Stitch Fix, ANGI is gaining market share in a huge industry -- Americans spend about $400 billion a year on home services, though much of those arrangements are made through traditional methods like word-of-mouth and referrals.
The company is aiming for long-term revenue growth in the 20%-25% range, and its HomeAdvisor-based marketplace business has driven stronger growth than that, with revenue up 27% in its most recent quarter. ANGI, which emerged from the 2017 merger between HomeAdvisor and Angie's List, is also seeing a promising turnaround at Angie's List, which posted revenue growth in the third quarter for the first time since the merger.
In other words, the business appears to be gaining momentum, and the stock is just coming off of all-time lows after shares plunged in August due to search marketing issues in its second-quarter report, setting up a good buying opportunity. The company should also see consistent long-term growth as millennials, who are more comfortable searching for things like home services on the internet, become homeowners.
In the recent earnings call, management warned that margins could narrow as it invests in its new Fixed Price services next year, but the marketplace model should eventually deliver solid profits as the company builds market share and solidifies its customer base.
Facebook needs little introduction. The social network counts more than 2.8 billion users among its family of services, which include Instagram, WhatsApp, and Facebook Messenger, and has established a vast fortress of competitive advantages, benefiting from both network effects and switching costs. A network of 2.8 billion people is unlikely to fall apart, at least not without government intervention, and advertisers, Facebook's true customers, love the service -- it and Google dominate digital advertising.
All of that is well known among investors, but what makes Facebook a Peter Lynch stock is its valuation. The company continues to put up enviable growth, but is still valued like an average stock. Backing out the $5 billion in Federal Trade Commission fines and a charge relating to a court decision, Facebook trades at a price-to-earnings ratio of just 23, equal to the S&P 500. The S&P 500 is growing earnings at 10.4%, while Facebook's adjusted earnings are up 15% through the first three quarters of the year. Its revenue is growing even faster, up 27% as the company continues to make investments in the business. That's much better than the S&P 500's revenue growth rate of 6.6%.
That combination of factors sets up an appealing combination. Facebook is growing faster than the S&P 500 and has a stronger set of competitive advantages than the average stock on the index, but the stock is trading at a discount for its growth rate. Additionally, the company has $52 billion in cash and investments that it can deploy for share buybacks or a future dividend. With growth opportunities both in new advertising products and entirely new businesses like Facebook Pay, there is good reason to believe that the company will continue to outgrow the S&P 500.