Applying John Neff's Low P/E method

(TLDR: John Neff's low P/E is inverse PEG with extra steps. ) John Neff was a low P/E investor who ran the Vanguard Windsor Fund from 1964 to 1995, his record was 13.7% a year versus the 10.6% of the S&P 500. Over the 31 years, his performance doubled that of the S&P500. In this post, i am going to look at his low P/E method as described in Chapter 7 of his book, "John Neff on Investing". This chapter can be gotten [here](https://docs.google.com/document/d/1dbwATYxQwo-hjPo4kboo9IdZjGPkWfjYSpaO1SJZHQs/edit?tab=t.0#heading=h.v6sc0fqaiy0f). He looks for low P/E stocks with a minimum EPS growth of 7%. Instead of a straight fixed P/E ratio (eg. say P/E <10), he uses a Total Return Ratio to calculate the attractiveness of the stock, the TRR is somewhat similar to Peter's Lynch's PEG but it includes Dividend yield. He then compares the TRR against the S&P 500 TRR so that it adjusts for overall market valuation. |Super Investor|John Neff|Peter Lynch| |:-|:-|:-| |Valuation name|Total Returns Ratio|PEG ratio| |Formula|TRR = (3-5 year EPS growth Rate + Dividend Yield) / P/E Ratio|PEG = P/E Ratio / LT Growth Rate| |P/E Ratio used|Not specified but examples used in Chap 7 & 8 hints at P/E based on FWD EPS.|Based on Trailing 12 Months.| |Dividend Yield|Based on Current Dividend (not past)|None used in PEG calculation| |Guidelines|Buy when TRR is > 2|"The p/e ratio of any company that's fairly priced will equal its growth rate."| ||Buy when TRR of stock is bigger than 2 x of TRR of Market|"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."| |Growth Rate Guidelines|minimum 7% and Maximum 20% CAGR|Beware of fast growers >25%| |Other Comments|Neff classifies his companies by growth rates: Highly recognized Growth,Less-recognized Growth, Moderates and Cyclical. He scours the 52 week lows for potential candidates. He uses EPS growth rates to filter out the value traps.|In chapter 13, Lynch introduces a different formula to PEG but is identical to TRR: "A slightly more complicated formula enables us to compare growth rates to earnings, while also taking the dividends into account. 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. Less than a 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"| The concept of the Total Returns is that you can expect to get a annual return on your investments equals to the long term (3-5 years EPS growth rate) + Dividends yield. Referencing the recent article on [Medical Tech companies](https://www.reddit.com/r/ValueInvesting/s/Eh3qSRMwUz). I decide to apply John Neff's formula on these companies. Note that the company data is gotten from Zack's, which is accessible by all. |Company|Recent Share price|Next 5 year EPS Growth|Current Dividend Yield|Total Returns|EPS TTM|EPS FWD (Current Year EPS)|P/E TTM|P/E FWD|TR Ratio TTM|TR Ratio FWD| |:-|:-|:-|:-|:-|:-|:-|:-|:-|:-|:-| |ABT|103|9.4|2.45|11.85|5.26|5.52|19.58|18.66|0.605|0.635| |DHR|191|9.4|0.84|10.24|8.12|8.51|23.52|22.44|0.435|0.456| |ISRG|337|15.6|0|15.6|10.23|10.74|32.94|31.38|0.474|0.497| |MDT|83|6.3|3.46|9.76|5.53|5.94|15.01|13.97|0.650|0.698| |BSX|44|15.6|0|15.6|3.1|3.35|14.19|13.13|1.099|1.188| |EW|83|13.3|0|13.3|2.81|3|29.54|27.67|0.450|0.481| Obviously none of the TR Ratio (TTM or FWD) meet this low-P/E criteria of buying when the TRR > 2. However, the book also says to adjust it for the market valuation. **To calculate the TR Ratio of the S&P500:** Total returns of the S&P500 = Next 5 year growth rate + dividend yield = 12.35 + 1.16 = 13.51 P/E (FWD) of the S&P 500 = 21.12 (morningstar) P/E (TTM) of the S&P 500 = 25.17 (WSJ) Hence, TRR of the S&P 500 TTM = 13.51 / 25.17 = 0.5368 TRR of the S&P 500 FWD = 13.51 / 21.12 = 0.6397 The book says, if the stock TRR > 2 x S&P 500 TRR, then it is worth pursuing. |Company|TR Ratio (TTM)|2 x S&P TRR (TTM)|TR Ratio (FWD)|2 x S&P TRR (FWD)| |:-|:-|:-|:-|:-| |ABT|0.605|1.0736|0.635|1.2794| |DHR|0.435|1.0736|0.456|1.2794| |ISRG|0.474|1.0736|0.497|1.2794| |MDT|0.650|1.0736|0.698|1.2794| |BSX|**1.099**|1.0736|1.188|1.2794| |EW|0.450|1.0736|0.481|1.2794| |||||| As you can see, only BSX partially meets this criteria. When I ran this a couple of days ago, the P/E (FWD) of BSX was at 12.807, it has since risen to 13.13. But since the BSX TR Ratio (FWD) is borderline that twice of the S&P TR Ratio, i would say that out of the 6 companies, BSX looks most attractive in terms of valuation via John Neff's method. \--- I will continue to test this against my watchlist of stocks. And monitor it to see how performs over time.