Legendary mutual fund manager Peter Lynch made his fame by generating outsized returns investing in growth companies. He is willing to pay up for faster-growing companies. He famously said that he would rather pay a price-to-earnings ratio (P/E) of 20 for companies that grow 20% than a P/E of 10 for companies that grow at 10% a year. 

This brings us to the concept that we call "Peter Lynch Fair Value" in our valuation box.

In determining the fair value of companies, Lynch uses a rule of thumb which says that the fair P/E of growth companies is equal to its earnings growth rate. Lynch is willing to buy a growth company at a P/E multiple that is equal to its growth rate (G). Therefore, to Lynch, at fair value, the PEG ratio of a growth company should be 1.

Because of this, the calculation of Peter Lynch Fair Value is very straightforward. It simply equals to the growth rate multiplied by its earnings. That is: 

Peter Lynch Fair Value = Earnings Growth Rate X Earnings.

Therefore, if a company grows its earnings 20% a year, according to Lynch, its fair valuation is 20 times its earnings.

So how much is Lynch willing to pay for Apple (AAPL) shares?

Apple has been able to grow its earnings per share at more than 60% a year, which is the result of tremendous revenue growth and margin expansion.

Apple earned more than $40 a share for the trailing twelve months. If Apple is worth a P/E of its growth rate of 60, the stock would be worth more than $2,400 a share. Of course, Lynch would only be willing to pay a P/E of 20 for the companies that grow faster than 20% a year. In this case, Apple shares would be worth about $1,000 a share to Lynch. Apple is now traded at around $660 a share, suggesting a 33% discount to Peter Lynch.

Apple stock has always traded at a discount compared with this fair value, but it did follow the trend in this chart. We don't know if Lynch owns Apple in his personal portfolio, but it is indeed a popular stock among the hedge fund gurus we track. Owning this stock has definitely been rewarding.

Disclosure: The author does not have a position in Apple stock.

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