Who was Peter Lynch, and what is the Lynch Screen?
Peter Lynch ran Fidelity's Magellan fund from 1977 to 1990, and the numbers still stop people cold: he compounded roughly 29.2% a year over those 13 years, beat the S&P 500 in 11 of them, and grew the fund from about $20 million in assets to $14 billion. That record made him the most-followed stock picker of his generation. The Lynch Screen is AAII's effort to turn his method into rules — a strictly bottom-up filter that hunts for growth companies selling at a reasonable price, drawn from the approach Peter Lynch spelled out for ordinary investors.
His core conviction ran against Wall Street orthodoxy: individuals have an edge over the professionals, not a handicap. A shopper spots a product flying off the shelf, a packed store, or a supplier quietly taking share long before the analysts write it up. "Invest in what you know" was his phrase for that advantage. He reached ordinary investors through two bestsellers — One Up on Wall Street (1989) and Beating the Street (1993), both written with John Rothchild, and together they have sold millions of copies.
The core idea: growth at a reasonable price
Lynch wanted growth but refused to overpay for it — the discipline usually shortened to GARP. He sorted companies into categories, among them fast growers, stalwarts, and cyclicals, and judged each against the "story" that fit it, since a cyclical and a fast grower are supposed to behave nothing alike. He all but ignored macro forecasts; in his own words, "If you spend more than 13 minutes analyzing economic and market forecasts, you've wasted 10 minutes."
His favorite valuation test tied price directly to growth. The plain PEG ratio divides the price-earnings ratio by the earnings growth rate — a P/E at half the growth rate is cheap, above 2.0 is dear. Lynch refined it by adding the dividend yield to the growth rate, on the logic that dividends are part of what you actually earn. Divide the P/E by growth-plus-yield and you get a dividend-adjusted PEG: above 1.0 is poor, and 0.5 or lower is where he wanted to buy. He paired that math with a taste for neglected niche businesses — dull companies that dominate an unglamorous corner of the market, the kind Wall Street overlooks and therefore never bids up.
What the Lynch Screen looks for
- No companies in the financial sector, since their balance sheets don't line up cleanly against other industries.
- No stocks that trade over the counter (OTC).
- A current price-earnings ratio below the median P/E for the company's own industry.
- A current price-earnings ratio below the company's own five-year average P/E — which also requires five years of positive earnings and price history.
- A dividend-adjusted PEG — the P/E divided by the sum of the five-year EPS growth rate and the five-year dividend yield — no greater than 0.5.
- A five-year growth rate in earnings per share from continuing operations below 50%, screening out growth too hot to last.
- Institutional ownership below the median for the entire database, Lynch's test for stocks the crowd has overlooked.
- A total-liabilities-to-total-assets ratio, measured for the latest fiscal quarter, below the industry median.
Why the approach can work
Each filter closes a specific trap. The two P/E tests — against the industry and against the company's own history — guard against paying up simply because a stock has been rising. The dividend-adjusted PEG, capped hard at 0.5, is the engine of the screen: it demands a lot of growth and yield for every point of P/E, so a name only clears the bar when the market has not yet priced its prospects in. Holding five-year earnings growth below 50% keeps out companies whose torrid numbers can't repeat — Lynch preferred earnings expanding at a steady 20% to 25% in a boring industry over a flash that fades. The low institutional-ownership rule chases his bargains-in-neglected-corners instinct, and the debt test screens out fragile balance sheets, since Lynch was wary of bank debt that can be called in exactly when a company can least afford it.
What to keep in mind
The 0.5 PEG cutoff is demanding, and in an expensive market the screen can return almost nothing — that scarcity is a feature, but it means the strategy can sit idle for long stretches. The five-year data requirement rules out recent IPOs and young fast growers, the very stocks Lynch made his name on. Backward-looking filters can also be fooled: a company whose growth is already decelerating may still clear a rule built on the trailing five years. Low institutional ownership often points to thin, illiquid small caps, and financials are excluded outright. Most important, the screen produces candidates, not conclusions — Lynch's edge came from understanding the story behind a company and rechecking it every few months. Know why you bought, or you won't know when to sell.
Sources
One Up on Wall Street, Peter Lynch with John Rothchild, 1989.
Beating the Street, Peter Lynch with John Rothchild, 1993.
American Association of Individual Investors (AAII) — Stock Investor Pro screen definition and commentary.