3 Stocks Peter Lynch Would Buy: AFL, ACE, AAP

Whenever I do a stock screen, I always make sure to do my “Lynch Screen” to see if stocks that utilize legendary mutual fund manager Peter Lynch’s criteria turn up anything interesting. I don’t always leap at every stock the screen turns up. I use it as a starting point to see if the stocks have a place in my portfolio. Today, my screen turned up three interesting names that merit further attention.

I started quacking like a duck when I saw the first name was Aflac Inc. (NYSE:AFL). It scored on one of my main criteria when evaluating any stock — the yield-adjusted PEG ratio. It’s calculated by taking the P/E divided by the sum of growth rate (average of three, four and five years out) plus dividend yield. I want this number to be less than 1.0, which indicates possible value. Anything under 0.5 is a screaming “buy,” and in this case, Aflac comes in at 0.49. Another part of the screen is that EPS must be positive, which it is.

For a financial company, Lynch requires the equity-to-assets ratio to be above 5%, and Aflac’s is at 11%. One can measure a financial’s profitability based on its return on assets, which is at 1.75%, above Lynch’s 1% minimum.

There are two bonus categories: free cash flow and net cash. If FCF-to-price ratio is above 35%, and net-cash-to-price ratio is above 30%, the company looks all the more attractive. Aflac doesn’t quite cut it here, with 8.65% and 10.2%, respectively. I also like that it is a brand name and is an insurance business, which historically is a good business to be in. Free cash flow consistency also is important to me, and Aflac’s has been remarkably consistent over the past few years.

Wouldn’t you know it, but another insurance company passed the screen. ACE Limited (NYSE:ACE) deals not only in all the standard insurance products, but also more exotic lines likes political risk, marine, energy and aviation. It also has a global reinsurance unit. Plus, it’s Swiss. I love the Swiss because they tend to be very precise in things like underwriting and financial management.

ACE did very well in the recession and, according to Lynch, could return as much as 50% given its stalwart status and earnings growth of 12%. Yield adjusted PEG is 0.96 — not a screaming “buy” but slightly cheap. EPS is positive at almost $7 per share. Equity-to-assets ratio is a health 27%, while ROA is at 2.15%. No bonus points on FCF or net cash, although those numbers are good and FCF has been very consistent year to year.

The final choice is not an insurance company, but is in a sector that certainly benefits from insurance: auto parts! Advance Auto Parts (NYSE:AAP) is massive — it has 3,369 stores in North America. The company did just fine during the recession and came roaring out of it. Its growth rate is stellar at 17%, giving it a yield-adjusted PEG of 0.88. The total debt-to-equity ratio of 74% is high for this screen, but it has a 1.2% net-cash-to-price ratio and 7.9% FCF-to-price ratio. These, plus the fact that it regularly pumps out a half billion dollars in free cash flow every year, compensate for that higher debt-to-equity ratio.

Of these, dividend investors also might like Aflac, as it pays 3% versus 2% for ACE and 0.4% for Advance. Of course, these are just a few criteria. You must check to see if they have a place in your own diversified portfolio.