Peter Lynch
Lynch's GARP: pay less for growth than the growth is worth
Growth investors and value investors argue about which number matters. Lynch's answer was to divide one by the other: a P/E below the company's own growth rate — a PEG under 1 — means the growth costs less than it is worth. The ratio is simple enough to compute in a minute, which is exactly why the work lives elsewhere: in deciding whether the growth number in the denominator can be believed.
- Approach
- Mechanical
- Difficulty
- Intermediate
- Horizon
- Long term (years)
- Holding period
- One to three years
- Time needed
- Two hours per position per quarter
- Markets
- Mid-cap growth stocks · Consumer and industrial names
- Source
- One Up on Wall Street (1989) — Peter Lynch
The rule set
- Compute PEG as the P/E ratio divided by the earnings growth rate
- Buy below 1: the growth costs less than it is worth
- Require the P/E itself to be sane — a low ratio built from an absurd multiple and an absurd growth rate is not a bargain
- Require modest leverage, because debt is what turns a slowdown into a crisis while you wait
- Sell when the price has run far ahead of the growth that justified buying it
What makes it distinctive
- Bridges growth and value instead of arguing about which is better — the test is growth per unit of price, not either number alone
- The PEG ratio makes 'expensive' relative to something rather than absolute, which is what lets it buy a P/E of 18 and refuse a P/E of 12
- Lynch's own framing — know what the company does before you touch the numbers — keeps the method usable by a non-specialist
When it works
Mid-cap companies in an established growth phase, before the market has fully priced the trajectory — the stretch after a business has proven it can grow and before every analyst covers it.
When it fails
Growth rates are the noisy part of the ratio: one exceptional quarter makes PEG look wonderful right before the comparison base resets. Cyclicals look cheapest on PEG exactly at the top of their cycle, which is the single most expensive mistake the ratio invites.
How a decision moves through it
Input
Five years of reported fundamentals, plus daily prices
The screen needs earnings, debt and equity from filings as well as a price feed. Reported figures update quarterly, which is why the system's natural rhythm is the reporting calendar rather than the chart.
Measure
P/E, debt-to-equity, and year-over-year EPS growth
Three numbers per company. Nothing here is exotic — every one of them is on the first page of any stock profile — and that accessibility is part of Lynch's argument for why an individual can run this at all.
Decide
Growth costs less than it is worth
P/E positive and below 20, EPS growth above 20% year over year, debt-to-equity below 1. The first two halves are the PEG under 1, written out: the engine's condition card compares columns against numbers and cannot divide one reported figure by another, so the ratio ships as the two thresholds that produce it.
Act
Buy, and let the reporting calendar do the checking
There is no chart pattern to wait for. Once the three conditions hold, the entry is the same day — the method's timing claim is that the market has mispriced the growth, not that a technical setup exists.
Decide
Exit once the price runs ahead: P/E above 30
The sell rule mirrors the buy rule. A multiple of 30 against growth of 20% is a PEG of 1.5 — the growth is now costing more than it is worth, and the reason for owning the stock has been paid out.
Size & protect
A 20% stop underneath the whole position
The shipped parameter. Lynch's own sell discipline was about the story changing rather than the price falling; the stop is the mechanical stand-in for a judgement the engine cannot make.
The ratio's real contribution: 'expensive' becomes relative to something
A P/E of 25 is not a fact about a stock. Against earnings shrinking 10% a year it is ruinous; against earnings growing 40% a year it is cheap. Lynch's rule of thumb — the P/E of a fairly priced company roughly equals its growth rate — turns that observation into a number: divide the P/E by the growth rate, and anything below 1 means you are paying less for the growth than the growth is worth.
This is what separates GARP from both camps it borrows from. A pure value screen refuses every P/E above 15 and so never owns a fast grower; a pure growth investor pays any multiple and so owns the crash when it compresses. The PEG buys the P/E of 18 growing at 25% and refuses the P/E of 12 growing at 4%.
Three thresholds stand in for one ratio
As shipped, the screen is three conditions: a P/E that is positive and below 20, earnings per share growing more than 20% year over year, and debt-to-equity below 1. The first two are the PEG under 1 written as its halves — inside that band, a multiple under 20 against growth over 20% is a ratio under 1 by construction. The third is the condition that lets you hold for the one to three years the thesis needs.
The band matters as much as the ratio. A stock with a P/E of 90 and growth of 95% also has a PEG under 1, and Lynch would not have touched it — a 90 multiple prices in a decade of perfection, and the growth number holding at 95% for even two more years is close to unprecedented. Capping the P/E at 20 is how the screen encodes 'the ratio must be built from sane inputs', which is a rule the ratio alone cannot express.
The formula came out of a method, and it was never meant to run naked
In the book, the PEG test appears after a hundred pages about knowing what a company does — watching what people buy, reading the story before the numbers, being able to explain the business in two minutes. The ratio was the pricing check applied to companies an investor already understood, not a screen for generating candidates from nothing.
That order of operations is not sentiment. The growth rate in the denominator is a forecast wearing a historical costume, and the only defence against a broken forecast is understanding where the growth comes from. A screen can verify that earnings grew 25% last year; only the story can tell you whether the thing that caused it is still happening.
Five ways into this system
- The PEG rule in full: the ratio, the sanity band, the debt test and the sell triggerFour rules, and the arithmetic that connects them. The ratio is the famous part; the band around it and the balance-sheet condition are what make it survivable.8 min read
- Sizing a GARP portfolio: a basket of stories, and what the 20% stop is standing in forLynch's actual risk control was diversification across stories plus the discipline to re-check each one. The stop in the shipped system is the mechanical stand-in for the judgement half of that.6 min read
- Where GARP hunts: mid-caps, the categories it actually catches, and the quarterly rhythmThe screen has a home ground: mid-sized companies in an established growth phase, under-covered enough to be mispriced. Two of Lynch's six categories pass it; the other four fail it by construction, and one of those failures is a trap.6 min read
- How GARP fails: the noisy denominator, the cyclical trap, and multiples that stay compressedEvery failure of this system is a failure of the number in the denominator. The arithmetic never breaks; the growth rate it divides by does, in three distinct ways.7 min read
- GARP for beginners: one division, and the three questions around itThe whole method is one division and three questions: is the growth real, is the price sane, can the company afford the wait. Everything else on these pages is those three questions in more detail.7 min read
The ideas behind it
This system assumes you already know these. Each one is explained from scratch in Investing 101.
Compare with
- Magic FormulaRank the whole market on return on capital, rank it again on earnings yield, buy the names that score best on both combined, and hold each one for a year.
- CAN SLIM Growth SystemBuy the market's leading growth stocks — accelerating earnings, institutional buying, a fresh high — but only from a proper chart base, and only while the market itself is advancing.
These are documented methods described for study. Nothing here is investment advice, a recommendation, or a claim about future returns — every system on this page has losing periods, and the pages say where.
Reading about a system is not having one.
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