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3 Tech Stocks Peter Lynch Would Like

By Keith Noonan, Sean Williams, and Brian Feroldi – Mar 13, 2016 at 6:22PM

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If these three Fool contributors are correct, these stocks fit the Peter Lynch investment mold.

Source: Wikimedia Commons; Author: Jericho

Peter Lynch is one of the world's most successful and revered investors, having parlayed his analytical prowess and investment philosophy into incredible returns. As the manager of Fidelity Magellan Fund from 1977 to 1990, Lynch helped the fund's holdings grow from $20 million to $14 billion, reportedly delivering average annual returns of 29% over the stretch and outperforming the S&P 500 in all but two years of his tenure. Lynch also introduced and popularized a way of thinking about investments that has made Wall Street more accessible to the average person.

His popular maxims, including "Invest in what you know" and "Never invest in any idea that can't be illustrated with a crayon," have been solidified as some of the most-repeated investment advice ever, and his books, including One Up on Wall Street and Beating the Street, have influenced generations of investors. At the heart of Lynch's philosophy is an imperative to locate good companies with favorable valuations and strong growth prospects, and to help investors locate stocks that fit the Peter Lynch mold, we've asked three Motley Fool contributors to weigh in on a stock that fits the famous financial guru's investment style.

Sean Williams: Peter Lynch was a mastermind when it came to finding value, but he didn't always use the most traditional instruments to locate that value. For Lynch, the price-to-earnings-to-growth ratio, price-to-cash flow, and debt-to-equity always seemed to play a key role in locating potentially undervalued stocks. When perusing the tech sector, perhaps no company epitomizes the Lynch investing ethos better than Kulicke & Soffa (KLIC -0.35%).

Kulicke & Soffa develops solutions for the semiconductor industry to streamline the chipmaking process. Its equipment aids in the process that ultimately puts the chips in your cell phones, computers, and automobiles. With the need for semiconductors only expected to rise, one would be left to assume that the company's equipment market opportunity is only expected to grow.

The downside of a company like Kulicke & Soffa is that the semiconductor equipment industry is quite cyclical and very dependent on the health of the U.S. economy. Translation: Growth can be a little lumpy when taken on a quarter-to-quarter basis.

However, if you look at the bigger picture and take some of the aforementioned value metrics into consideration, you'll get a better understanding of why Peter Lynch might love this stock. For starters, Kulicke & Soffa has just $57.2 million in long-term debts compared with $493 million in cash and cash equivalents. This works out to $435.8 million in net cash and a current valuation for the company of just $796 million. This cash helps protect Kulicke & Soffa during cyclical downturns and it provides great flexibility when making earnings-accretive acquisitions.

The company is also trading slightly below book value, and at a PEG ratio of just below 1. Generally, a PEG ratio below 1 implies an incredibly cheap stock, and with a long-term growth rate in the neighborhood of 10%, it's tough to argue that the bigger picture doesn't look bright for Kulicke & Soffa.

Brian Feroldi: Peter Lynch has been a master at finding and investing in high-growth consumer-facing companies that offer plenty of room for future expansion. One stock that I think would appeal to Lynch nowadays is TripAdvisor (TRIP -1.50%), which offers all of the qualities he found attractive in a fast-growing company. 

First, TripAdvisor has created a powerful brand name that resonates with millions of consumers. That's evidenced by the fact that more than 200 new reviews are added to the company's site every minute, and TripAdvisor now boasts a library of more than 320 million reviews on 6.2 million unique businesses around the world. The company's customers are attracted to this massive list of reviews, and TripAdvisor's website has become the first place millions of travelers visit when they're interested in researching and booking their next trip. This fact has turned the TripAdvisor name into a powerful consumer brand.

Next, TripAdvisor has proved itself to be very adept at converting all of those website visits into revenue. In 2015 the company generated more than $1.49 billion in total revenue, a number that has compounded at a 25% annualized rate over the past five years. The company's "Instant Booking" feature is proving to be popular with both travelers and businesses alike as it has already signed up eight of the top 10 global hotel chains.

Finally, even with its current size and scale, TripAdvisor has barely scratched the surface of what's possible, as total worldwide spending on travel is a $1.3 trillion market. That means that even if TripAdvisor grew its revenue by tenfold from here, it would have captured only 1% of the total pie. That enormous addressable market opportunity gives this company plenty of room to continue its fast growth for years to come.

Yet despite everything that the company has going for it, TripAdvisor's stock is currently out of favor with Wall Street. Shares are down more than 30% from their 52-week high, and the company is trading for roughly 31 times its 2016 earnings estimates. That's a perfectly fair price that I'd wager even Lynch himself would find attractive.

Keith NoonanPeter Lynch may or may not be an avid player of the Grand Theft Auto video game series, but franchise publisher Take-Two Interactive (TTWO 2.22%) fits nicely into the growth-story approach that's hiding beneath the surface of his popular "invest in what you know" mantra. Rather than suggesting that investing in companies investors have personal experience with offers some innate path to success, Lynch's most famous investing advice more accurately suggests that familiarity gives investors valuable tools to construct and analyze growth stories. 

Lynch's investment philosophy prizes growth, and the famous investor identified cutting costs, moving into new markets, building in existing markets, raising prices, and improving or liquidating bad assets as the five ways in which a company can grow. Take-Two is doing well on each of these fronts. The overall cost of developing triple-A video games is rising significantly, however, Take-Two is deriving an increasing portion of its sales from digital content that yields much better margins than physical media sold through retail channels. With growing domestic and international demand for interactive entertainment, and a consumer base that's paying more for their gaming experiences through add-on content purchases, Take-Two looks good on a Lynchian growth level. The company has also shown that it can take a fiscally responsible approach to struggling assets -- having closed and reshuffled development studios that failed to live up to commercial expectations.

Take-Two's growth story is relatively uncomplicated and easily passes Lynch's "never invest in an idea you can't illustrate with a crayon" test: The company wants to sell more gaming content by building and strengthening franchises -- and it performs better when it accomplishes this through digital channels.

Take Two's earnings are irregular because of the company's development cycles and small size, which makes some of Lynch's preferred earnings-based metrics relatively opaque, but a debt-to-equity ratio of just 0.16 would probably please the famous investor, and a strong content lineup and favorable industry conditions give the company fast-growing potential. 

Brian Feroldi owns shares of TripAdvisor. Keith Noonan owns shares of Take-Two Interactive. Sean Williams has no position in any stocks mentioned. The Motley Fool owns shares of and recommends TripAdvisor. The Motley Fool recommends Take-Two Interactive. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Stocks Mentioned

Take-Two Interactive Software Stock Quote
Take-Two Interactive Software
$108.76 (2.22%) $2.36
TripAdvisor Stock Quote
$20.31 (-1.50%) $0.31
Kulicke & Soffa Industries Stock Quote
Kulicke & Soffa Industries
$47.78 (-0.35%) $0.17

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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