Peter Lynch built an investing empire through the Fidelity Magellan Fund, a mutual fund comprising growth stocks that walloped the average annual return of the stock market. But he’s handed down invaluable lessons for individual investors, too, including some that funds managing many billions of dollars in assets aren’t nimble enough to exploit. Invest in what you know, diversify among those areas, and find stocks Wall Street might be overlooking.
Easy, right? Well, it takes an avalanche of research and even more patience. That’s why we asked a trio of contributors at The Motley Fool for some ideas to get your research started on the right path. Here’s why they chose SolarEdge Technologies (NASDAQ:SEDG), A.O. Smith (NYSE:AOS), and Square (NYSE:SQ).
A leading clean energy hardware provider
Maxx Chatsko (SolarEdge Technologies): The business is on pace to eclipse $1 billion in revenue during a calendar year for the first time in history. It’s comfortably profitable. It’s diversifying from inverters and power optimizers for the solar industry to energy storage products, electric-vehicle chargers, and even electric-vehicle powertrains.
Despite all that, shares of SolarEdge trade at a PEG ratio of just 0.8 and less than 15 times future earnings. Investors with a long-term mind-set might find the business to be even more of a bargain than that thanks to two megatrends: solar and electric vehicles.
The amount of electricity generated from solar energy is growing at over 20% per year in the United States. While it’s growing from a small base, the energy source represents over 2% of total electricity production. It will become a go-to for new power projects as costs continue to drop, which promises to lift it to over 10% of America’s electricity mix by 2030.
Electric vehicles promise to obtain a similarly impressive growth trajectory. Nearly every major automaker — and several upstarts — will launch electric vehicles into the market in the next few years. A glance at long-term supply contracts and market projections from Albemarle, the world’s largest lithium producer, reveals it’s not just a fad. Annual lithium demand is expected to soar to as much as 1.2 million metric tons in 2025, up from just 175,000 metric tons in 2015.
Simply put, profitable growth, bold bets on diverse megatrends, and an attractively valued stock make SolarEdge Technology a stock Peter Lynch would love.
This growth stock’s recent drop calls for attention
Neha Chamaria (A.O. Smith): “Invest in what you know” is perhaps one of Peter Lynch’s most popular quotes. By this, Lynch doesn’t just mean investing in a company that manufactures a product or a service that’s easy to understand, but also a company with a strong foothold in its industry and visible growth catalysts. And for Lynch, being able to find such a stock at a bargain price is cherry on top. Case in point: A.O. Smith.
To start, A.O. Smith is the world’s largest manufacturer of water heaters and boilers. Now, regardless of how the economy is faring, you’d buy or replace a water heater as and when needed, whether for residential or commercial purposes. That means on the one hand, resilient replacement demand for such products generate a steady flow of income for manufacturers. On the other hand, global macro trends such as a rising middle class and urbanization fuels fresh demand, offering manufacturers an opportunity to tap new markets for growth. A.O. Smith, for example, has its eyes set closely on China and India, two of the world’s most populous countries with favorable demographics for consumer durables products.
A.O. Smith’s impressive operational performance in recent years further bears testimony to the pricing power it commands — another characteristic Lynch would love to see in a company.
Despite a seemingly great growth story ahead, A.O. Smith shares have lost nearly one-third value in the past one year, partly because of a slowdown in China — already a big market for the company — and a scathing recent short-seller report. Thanks to which, A.O. Smith is now trading considerably below its five-year average valuation based on price-to-earnings, price-to-cash flow, and enterprise value-to-EBITDA ratios. Of course, A.O. Smith has its fair share of risks like any other company, but global dominance and a massive addressable global market make for a compelling Lynch-style investing thesis.
Bet on this simple middleman
Chris Neiger (Square): One of Peter Lynch’s approaches to buying stocks comes from the idea that you should be able to understand what that company does in straightforward terms. “The simpler it is, the better I like it,” Lynch once said. I like to think Square fits this description because, at its core, the company is simply a middleman between merchants and customers, helping the two parties exchange money for goods and services.
The company’s mobile card readers, point-of-sale terminals, and its Square Cash app are all ways that help people easily make purchases or transfer money between each other. The company’s investment in this tech is also what gives it an advantage in consumers’ shift toward cashless transactions. By 2023, the global contactless payment market will be worth $27.2 billion, up from $8.7 billion just two years ago, and Square is already starting to dominate the space.
Square’s Cash app had 15 million monthly active users at the end of its first-quarter 2019, double the number of its users it had in the year-ago quarter and the total dollar amount transacted through the app was up 2.5 times compared to Q1 2018. Other highlights from the most recent quarter include revenue growth of 43% year over year and an EBITDA increase of 72%.
Despite Square’s share price jump of 600% over the past three years, this company is just getting started in the cashless payments and purchases market. Investors looking for a straightforward business with growth potential that Peter Lynch would approve of need to give Square strong consideration.
