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Published: August 26, 2010
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:
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A boring name performing a service in a boring area
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The company does something many people might find disagreeable
-
The company is a niche firm controlling a market segment with
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 Steier
Contributor
StreetAuthority |
