Serious Money: Buying the Super Caps, Part 3

Posted May 19th 2010 12:10PM by Sheldon Liber
Filed under: Competitive Strategy, Microsoft (MSFT), General Electric (GE), Wal-Mart (WMT), Exxon Mobil (XOM), Johnson and Johnson (JNJ), Bank of America (BAC), Procter and Gamble (PG), PetroChina Co Ltd ADR (PTR), Wells Fargo (WFC), Serious Money, Stock Screen, China Mobile Limited (CHL)

Over the years I have referred to "my pal Warren" (Warren Buffet) on many occasions. He has taught me a great deal. I have learned a few things from Sir John Templeton (RIP) as well. But when I think about the price-to-earnings-to-growth (PEG) ratios, it is Peter Lynch who stands tall.

Lynch has been retired for many years and has been generous enough to share some of his thoughts in a couple of worthy books: One Up on Wall Street and Beating the Street. I highly recommend these best sellers to anyone that wants to expand their knowledge of value investing or manage their own finances.

In case it has never come to your attention before, Lynch was the original manager of Fidelity's Magellan Fund, taking it from $20 million to $50 billion in 13 years.

One of the things that he emphasized was the rate of growth a company was achieving. It is really this growth that helps make some sense of the P/E ratio. After all, a P/E may appear high at first glance, even twice that of its competitors, but it does not matter if it is growing three times as fast. We continue our super cap review with this in mind.

Lowest price-to-growth to highest

Exxon Mobil (XOM) 0.65
Walmart (WMT) 1.19
General Electric (GE) 1.2
Microsoft (MSFT) 1.4
Wells Fargo (WFC) 1.55
PetroChina (PTR) 1.59
Johnson & Johnson (JNJ) 1.71
Procter & Gamble (PG) 1.95
China Mobile (CHL) 3.14
Bank of America (BAC) 3.53

Ideally you would want to find stocks with a PEG of 1.0 or less as a deep value, and most gurus using this metric would shun stocks over 2.0. The higher the growth rate, the lower the PEG, the cheaper the stock.

For myself, I tend toward the stocks with PEGs under 1.5, seeking deeper value and a larger margin of safety. If we cut Wells Fargo a little slack here, then five of the ten make the grade, although only two seem high. If one were to consider this metric alone, then Exxon appears to be a steal. It should be noted that China Mobil had the lowest P/E ratio in the initial story, so you can see why the PEG matters. If it has the lowest P/E ratio but also the highest PEG then maybe it is not the bargain it appears.

If Bank of America did not have the lowest P/B and P/S, as portrayed in the second post of this series, I would be cutting it today. Instead we will move on to compare the dividends in Part 4, keeping the ten stocks for now.

Sheldon Liber is the CEO of a small private investment company and the principal for design and research at an architecture and planning firm. He writes the columns Chasing Value and Serious Money. DISCLOSURE: At the time of this post he owned shares of GE, PTR, WFC, and options in BAC.

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