Peter Lynch is widely considered an investing legend. He led Fidelity Investment's Magellan Fund to a 29.2% average annual return from 1977 until his retirement in 1990, almost doubling the S&P 500's yearly return over that time. One Up on Wall Street -- Lynch's best-seller -- is a must-read that breaks down his investing philosophy into easy-to-understand concepts.
Lynch's most-oft quoted maxim is "invest in what you know," reflecting his belief that investing within one's circle of competence -- and interest -- provides an investor with an advantage.
We asked three of our contributors to channel their inner Peter Lynch and choose a consumer goods stock that the master investor would likely find attractive today.
Brian Stoffel: I read Peter Lynch's investing books just as my Foolish journey began; I remember my excitement at hearing a successful investor say that "buying what you know" was a viable strategy. Today, I'm suggesting a company many readers are likely familiar with, Michael Kors (NYSE:KORS).
The company's stock has taken a beating this year, down over 40%. That's largely because competition is taking a bite out of business, and investors are wondering how sustainable the strength of the company's brand really is. When earnings were announced in late May, comps declined by 5.8%, and gross margins contracted by 162 basis points as the company had to slash prices on goods to move inventory.
But the business is still solid. Kors has $800 million of cash on hand, and zero debt. In addition, much of the worry about the company being able to succeed in a highly competitive environment is already priced into the stock. It currently trades for just 15 times free cash flow, and 9.5 times forward earnings.
While investing in Kors could still be a losing bet if the company is unable to reconnect with customers, any progress in comps could signal huge upside for patient investors.
Tamara Walsh: Peter Lynch liked to find small-cap companies that weren't yet on institutional investors' radar. While soda and snack giant PepsiCo (NYSE:PEP) no longer meets that criteria, it measures up to the Lynch standard in other key ways. "Invest for the long run" was one of his main credos. Pepsi is a company that investors can confidently buy and hold for many years to come.
Additionally, one of Lynch's famous philosophies was to invest in companies with strong cash flows and below average debt. Pepsi fits the bill perfectly. Its Frito-Lay business boasts 22 brands that each generates annual sales north of $1 billion -- this helps create a favorable cash position for the company and its shareholders. The company has grown free cash flow 4% so far this year to $5.6 billion excluding certain items.
Pepsi's debt-to-total-capital ratio of 70% is in line with the industry. While that means Pepsi's debt is not quite "below average," the company still fits within Lynch's parameters given its interest coverage ratio of 15 and quick ratio of one. Together with Pepsi's ability to generate loads of cash, this means the company should have no problem repaying its debt, while also continuing to reward shareholders through dividends and buybacks.
PepsiCo is also a winning stock for long-term investors because it creates shareholder value through reliable dividends and rich share buybacks. The company has been paying a dividend every year since 1952, and has increased its payout for the past 43 consecutive years. Pepsi is on pace to return as much as $9 billion to shareholders in 2015 through dividends and share repurchases. Moreover, Pepsi's ability to generate strong cash flow means it should have no problem continuing to raise its payout for many more decades.
Together these things make PepsiCo a long-term consumer stock that would make famed investor Peter Lynch proud. Shares are currently trading around 29 times earnings or in line with the industry average.
Beth McKenna: The cornerstone of Peter Lynch's investing philosophy is "invest in what you know," so it's impossible for me to suggest a "Peter Lynch stock" for anyone that I don't know. However, if you naturally find yourself "up" on food trends and/or buy organic foods, I'd suggest that you explore WhiteWave Foods (NYSE:WWAV).
While the company's stock might fly somewhat under the radar, its flagship Silk brand is especially well-known, thanks to the soaring popularity of its line of plant-based beverages and foods. Cartons of Silk almond, soy, coconut, and cashew dairy-free beverages are pouring out of food stores everywhere. We're in the early innings of a global shift away from dairy beverages, yogurts, creamers, and frozen desserts to plant-based ones. WhiteWave is the dominant player in this fast-growing niche, so investors should be able to ride this investment wave into the horizon. It's also a major player in other rapidly expanding categories, most notably organic foods and beverages.
Lynch eschewed the popular price-to-earnings ratio in favor of valuation metrics that take growth or projected growth into account, such as the PEG (P/E to growth). WhiteWave gets solid marks here, sporting a 5-year PEG of 1.8 versus the industry average of 2.4. This PEG, in my opinion, could prove to be overstated as last quarter the company increased full-year 2015 guidance across the board, and continues to prove quite adept at strategic acquisitions.
While his other quantitative criteria varied, Lynch generally favored companies with strong cash flows and low debt. WhiteWave's 1.38 debt-to-equity ratio is middle of the pack; it's roughly the same as General Mills' 1.55 and Coke's 1.55. Its free cash flow, however, falls short. But there’s good reason: It's aggressively investing for growth, which is common for newer companies. Though WhiteWave has been around for some time, in a core way it's essentially a newer business. It was spun off from dairy giant Dean Foods beginning with an October 2012 IPO.
I have no doubt that the move toward plant-based foods represents a sustainable shift, not a shorter-term trend. So the main risk factor for WhiteWave involves increased competition resulting in commoditization.
Some investors may be comfortable buying now, while others might want to put "WWAV" on their watch lists to see if its cash flows and debt load become more "Lynchian" over time.
Beth McKenna has no position in any stocks mentioned. Brian Stoffel has no position in any stocks mentioned. Tamara Rutter owns shares of PepsiCo and WhiteWave Foods. The Motley Fool owns shares of and recommends PepsiCo and WhiteWave Foods. The Motley Fool owns shares of Michael Kors Holdings and has the following options: long January 2016 $37 calls on KO, short January 2016 $43 calls on KO, and short January 2016 $37 puts on KO. The Motley Fool recommends KO.
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