This Classic Peter Lynch Play Could Double Your Money
August 27, 2010By: Frederick M. SteierArticles RSS feedPrintPrint

It's easy to trot out legendary investor Peter Lynch's name every time you find an undervalued fast-growing company, but the truth is that Lynch had many different criteria that had to be met before he would purchase a stock.

I always keep certain Peter Lynch criteria in mind when I find an interesting company; so much so that I've got it memorized and can tick off the boxes in my head if I find a candidate.

Here are a few of the characteristics I look for in a "Peter Lynch" stock:

  • A boring name performing a service in a boring area
  • The company does something many people might find disagreeable
  • The company is a niche firm controlling a market segment with a high barrier to entry
  • The company produces a service that people tend to keep buying no matter what the economy is doing

[See: How to Invest Alongside the Great Value Investors]

This brings us to a stock that I think qualifies as a classic example of what Lynch would look for: World Acceptance Corporation (Nasdaq: WRLD). How's that for a boring name? The company makes medium-term consumer installment loans to people with poor credit. How's that for a boring business?

Is this a disagreeable business? You better believe it. The company has 910 locations in the United States and 80 in Mexico. Stores tend to be located in parts of cities that are not high-class, so there is an unfair image of the company setting up in downtrodden parts of the inner city.

The installment loan business had a number of bad eggs playing in the space for a long time, and a number of them were run out of town by state regulatory authorities for not playing fair with customers. If you do a search for articles written about World Acceptance, many decry the company's practices as "taking advantage of desperate people," or "as bad as the Mafia," or "bloodsuckers." World Acceptance, however, has always played by the rules.

As far as dominating a niche with a high barrier to entry goes, nobody wants to acknowledge that there is a huge portion of the U.S. and Mexican population in need of intermediate-term credit to make ends meet. The installment lender used to be a staple of middle-class America -- some may remember companies like Beneficial or AVCO that provided these types of services. They are long gone now, having been swallowed up by large banks or run out of business. World Acceptance now dominates this highly fragmented niche of the credit markets.

Because it deals in loans that average about $1,000 for an average term of nine months, World Acceptance does not see any competition from commercial banks and credit unions, which focus on loans of $5,000 or more. It is economically difficult for many lenders to stay in business because of the cost associated with underwriting such small loans and the relatively high rate of default. Because of this, the company's effective annual percentage rates on its loans range from 20% to 204%, with the weighted average coming in around 78%.

And because World's loans are unsecured, bad economic times are a boon to the company. Yes, defaults can rise if it the company isn't careful with its underwriting, yet defaults are always kept in a tight range. Meanwhile, net income has been steadily growing at a +20% annual rate from before the recession hit in 2008 through the present.

So far, so good. Here's the rundown on how Peter Lynch's quantitative analysis criteria stacks up for World:

-- Year-over-year earnings have been stable and consistent, growing at least +20%.

-- World's P/E ratio is only nine, giving it a PEG of 0.45 (Lynch's threshold was 0.5 or less).

-- I'd like to see World have more cash on hand (it only stands at about $6.3 million), but that's only because management is plowing it all into expansion. Aside from that, the company routinely throws off at least $150 million in free cash flow every year. Furthermore, World has a solid capital structure, with access to a nine-figure credit facility. Smaller players are nowhere near as well-capitalized.

I'll also add one other note, which is that World's net margin is 17% -- almost twice that of its cousin businesses, the payday lenders.

Action to Take --> Consider buying World Acceptance as a classic Peter Lynch value component to your portfolio.

The really impressive thing about this company is its consistency. In perusing annual reports for the past five years, I saw the same things year after year -- none of them bad. The company is vastly undervalued, has all the cash it needs to continue expansion, a manageable debt load of about $200 million, and has a rock-solid business model.


If, as Lynch says, stock prices follow earnings growth, then World Acceptance shares could double in four years or less.

Frederick M. Steier
Contributor, StreetAuthority.com
Readers Of This Article Also Enjoyed...
  • 5 Buyout Targets for Quick Gains in 2012

    The backdrop for deal-making has never been better. With these five buyout candidates, at worst you'll own solid businesses for the long-term -- at best you'll score a quick gain.

  • 2 Below-Book Stocks with BIG Upside (and Limited Downside)

    In an uncertain economy, it pays to play defense. These two stocks are trading well below book value, giving investors a welcome downside protection -- but while still offering plenty of upside.

  • Now's the Time to Buy Small Caps -- Especially These 2 Stocks

    If history is any guide, then it's time to buy. Here are two of my top picks...

  • These 3 Companies Could be Headed for Bankruptcy in 2012

    According to Fitch Ratings Inc.,  corporate bankruptcies in 2012 are expected to double in number in number and size from their 2011 levels. Could these 3 companies be the first victims?

  • 3 Small-Cap Stocks with Heavy Insider Buying

    These "off-the-radar" plays might deliver solid upside in 2012. Here's why...

    •

    LEGAL DISCLAIMER: SmallStocks.com and its parent company, StreetAuthority, LLC, are publishers of financial news and opinions and NOT securities brokers/dealers or investment advisors. You are responsible for your own investment decisions. All information contained in our newsletters or on our web site(s) should be independently verified with the companies mentioned, and readers should always conduct their own research and due diligence and consider obtaining professional advice before making any investment decision. As a condition to accessing our materials and web sites, you agree to our Terms and Conditions of Use, available here, including without limitation all disclaimers of warranties and limitations on liability contained therein. Owners, employees and writers may hold positions in the securities that are discussed in our newsletters or on our web site.