Peter Lynch on Price vs Value

Lynch popularised the PEG ratio — the price-to-earnings multiple divided by the earnings growth rate — as a quick check on whether a growth stock is being bought at a reasonable price. His rule of thumb was that a fairly priced growth company trades at a P/E roughly equal to its growth rate; a P/E below the growth rate is a bargain, a P/E well above it is a warning. The metric is deliberately crude because Lynch distrusted precise models: the inputs (next year's earnings, the long-run growth rate) are themselves guesses, and pretending otherwise builds false confidence. What the PEG ratio resists is the habit of paying any price for growth. A fast grower at fifty times earnings can still be a bad investment if growth slows to fifteen percent; the multiple compresses and the loss is real even though the underlying business did fine. Lynch preferred to find growers trading at twelve to fifteen times earnings when the growth rate was running at twenty, because the gap between price and growth provides a margin for error in the thesis. The discipline forces investors to think simultaneously about the quality of the business (its growth) and the price paid (its multiple), instead of optimising one at the expense of the other. Lynch extended the same logic to the balance sheet. A company with no debt cannot go bankrupt, which made net cash a quality marker he returned to repeatedly. He contrasted the financial engineer — a balance sheet loaded with debt and goodwill — with the operator whose business throws off cash faster than it can be deployed. The PEG is a price discipline; the debt test is a survival discipline. Together they screen out the two most common ways growth investors lose money: overpaying, and over-leverage.