🧮 Peter Lynch's Formula for Valuing a Stock's Growth

(Median Growth Rate + Median Dividend Yield) / (Median P/E)

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S&P500 Calculation and Weighting

The Standard & Poor's 500 index includes 500 leading American companies listed on the NYSE or NASDAQ and covers 80% of the available market capitalization.

■ Ticker symbols: $SPX | ^GSPC | INX

The S&P 500 stock market index is based on the market capitalizations of 500 large American companies with common stock. The S&P 500 was introduced in 1923 as the “Composite Index.” On March 4, 1957, it expanded to its current basket of 500 stocks. Today, it is one of the most traded equity indices in the world. The S&P 500 differs from other U.S. stock market indices because of its weighting method.

Calculation and Weighting

The S&P 500 has traditionally been a capitalization-weighted index. Since 2005, the index has calculated the market capitalization of each company using only the float-adjusted shares (shares available for public trading).

Table: Top 10 Shares by Index Weight in the S&P 500

COMPANY	SYMBOL	INDUSTRY
Apple Inc.	AAPL	I.T.
Microsoft Corp	MSFT	I.T.
Amazon.com Inc	AMZN	Consumer
Facebook Inc A	FB	I.T.
Johnson & Johnson	JNJ	Health Care
Berkshire Hathaway B	BRK.B	Financial
JP Morgan Chase & Co	JPM	Financial
Exxon Mobil Corp	XOM	Energy
Alphabet Inc A	GOOGL	I.T.
Alphabet Inc C	GOOG	I.T.

🔗 Find the full list at Wikipedia: https://en.wikipedia.org/wiki/List_of_S%26P_500_companies

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Applying Peter Lynch’s Formula to the S&P 500 (Median vs. Current Value)

In his book One Up on Wall Street (1989), legendary mutual fund manager Peter Lynch introduced a simple way to compare a company's growth with its stock price.

Here’s how it works...

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(1) Linking P/E to Growth Rates

Lynch believed that a company’s P/E ratio should roughly match its annual growth rate.

Here’s an example:

• If Company X has a P/E ratio of 10, its expected annual growth rate should also be 10%.

• If Company X has a P/E ratio of 35, its expected growth rate should be 35%.

👉 Lynch: "In general, a P/E ratio that's half the growth rate is very positive, and one that's twice the growth rate is very negative."

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(2) Linking Dividend Yields to P/E and Growth Rates

Lynch added another layer by including dividend yield in the equation.

Lynch: "Find the long-term growth rate (say, Company X’s is 12 percent), add the dividend yield (Company X pays 3 percent), and divide by the P/E ratio (Company X’s is 10). 12 plus 3 divided by 10 is 1.5."

Here’s how the Lynch Formula works:

1. Take the long-term growth rate (e.g., 10%)

2. Add the dividend yield (e.g., 2%)

3. Divide by the P/E ratio (e.g., 12)

Using the example: (10 + 2) / 12 = 1

👉 Lynch: "Less than 1 is poor, and 1.5 is okay, but what you're really looking for is a 2 or better. A company with a 15 percent growth rate, a 3 percent dividend, and a P/E of 6 would have a fabulous 3."

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(3) Applying the Formula to the S&P 500 (1871–2017 Median vs. Current Value)

Now let’s apply this formula to the S&P 500 and compare the historical median value (from 1871 to 2017) with the current value.

• Median Period: 1/1/1871-11/14/2017
• Current Close: 11/14/2017
• Data Source: multpl.com

Here are some basic figures for the S&P 500.

□ Current S&P 500 Earnings Growth Rate (2017/11/14): 16.02%

□ Median S&P 500 Earnings Growth Rate: 10.12%

□ Current S&P 500 Dividend Yield (2017/11/14): 1.87%

□ Median S&P 500 Dividend Yield: 4.31%

□ Current S&P 500 P/E Ratio (2017/11/14): 25.71

□ Median S&P 500 P/E Ratio: 14.67

Calculating the Median and Current S&P500 Value

Calculating the Median S&P500 Value

□ {(Median Growth Rate + Median Dividend Yield) / (Median P/E)} = {(10.12 + 4.31) / 14.67} = 0.984 (close to 1)

Calculating the Current S&P500 Value

□ {(Current Growth Rate + Current Dividend Yield) / (Current P/E)} = {(16.02 + 1.87) / 25.71} = 0.696 (significantly less than 1)

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Shiller P/E Ratio for the S&P 500

Chart: S&P 500 vs. Shiller P/E Ratio

Price-earnings ratio is based on average inflation-adjusted earnings from the previous 10 years, known as the Cyclically Adjusted PE Ratio (CAPE Ratio).

-Current Shiller PE Ratio: 32.33 (Nov 2017)

-Mean: 16.80

-Median: 16.15

-Min: 4.78 (Dec 1920)

-Max: 44.19 (Dec 1999)

Shiller PE Ratio, or PE 10. Data courtesy of Robert Shiller.

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S&P500 Trading Hours Profitability

The most profitable time to invest in the S&P500 is from the previous day's close until 10 a.m. EST (overnight positioning). The least profitable period is from 10 a.m. to 11 a.m. EST.

(↑) BEST TIMES TO GO LONG:

(1) From the previous day’s close to 10 a.m. EST (or 3 p.m. GMT)

(2) From 3 p.m. to 4 p.m. EST (or 9 p.m. to 10 p.m. GMT)

(↓) BEST TIMES TO GO SHORT:

(1) From 10 a.m. to 12 p.m. EST (or 3 p.m. to 5 p.m. GMT)

Source: SeekingAlpha.com, @PavelShishigin

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Short Conclusions

Based on the Lynch formula, the S&P 500 appears to be overvalued. To justify current levels, the index would need significantly higher growth rates or much higher dividend yields in the coming years.

 

■ S&P500 and the Stock Market Formula

G.Protonotarios for TradingCenter.org

Sources: Wikipedia.org, Multpl.com, SeekingAlpha.com, Yale.edu