Stock investing strategy- GARP

GARP investing was popularized by legendary Fidelity manager Peter Lynch. Growth at Reasonable Price (GARP) is a combination of both growth and value investing. While a growth strategy is more focused on a company’s earnings growth and value investing seeks companies having their prices below their intrinsic value, growth at reasonable price as a strategy, hunts for stocks that have both a growth potential and are also trading at a reasonable price. A typical GARP investor seeks to invest in companies that have had a positive performance over the past few years, and also have positive projections for the upcoming years.

What Is an Ideal GARP Stock?

In fact, the ideal GARP style stock would be one with above average growth potential in earnings and revenue for the future, greater than its peers in its industry group, but would also happen to be trading at a value or lower price than its fundamental analysis valuation target.

A GARP investor would buy stocks that are priced lower (but not as low as possible) than their fundamental analysis target but that also have good future prospects of growth in cash flow, revenue, earnings per share and so on.  In other words, a GARP investor tries to find stocks that will rise in value for two specific reasons:

  • Stock is priced under valuation target: One, if a stock is priced under its fundamental analysis valuation target, then over time, the stock should rise to that consensus target of what it is intrinsically worth, or its intrinsic value.
  • Stock has above average earnings potential: Second, if the stock has above average potential for earnings or revenue growth in the future, then the price of the stock should rise as the company grows in value, makes more sales, and increases its revenue and earnings per share in the future.

PEG and ROE ratio- The benchmarks for a GARP investor.

A solid benchmark to spot a GARP stock is PEG ratio or price/earnings growth ratio. The PEG shows the ratio between a company’s P/E ratio (valuation) and its expected earnings growth rate over the next several years. A GARP investor would seek out stocks that have a PEG of 1 or less, which shows that P/E ratios are in line with expected earnings growth. This helps to uncover stocks that are trading at reasonable prices.

Another ratio that’s relevant for a GARP investor is the Return on Equity percentage. Finding companies that have a consistently high ROE generally shows that you are dealing with good management and a strong business.

GARP is all about finding rapidly growing companies that are available for low PE multiples. If an investor gets it right, this strategy could yield multi baggers in due course of time because of two factors. One, the growth of the company and its per share earnings would increase over a period. Two, because it shows sustained growth over many years, its price to earnings ratio would get re-rated.

Advantage GARP.

  • A GARP investor will have a hybrid investment style that allows for some of the principles of a value investor and some of the principles of a growth investor-Truly the best of both worlds.
  • In value investing, one might miss a potentially good quality stock trading at reasonable valuations; one is more likely to spot the opportunity under the GARP style of investing.
  • Owing to the strategy employed by GARP, an investor is more likely to see his returns to be more stable than those of either a pure growth or value investor.
  • In a bull trend, it is the growth investor who will stand to benefit the most, followed by GARP and value investor.
  • In a bear run, the growth stocks will see big falls in their value than the GARP or value stocks.
  • Thus irrespective of the market movements, the GARP investor would strike the golden mean. His investments would yield reasonable returns

Conclusion.

GARP is a balanced approach to investing. It tends to combine the positives of value and growth strategies. A GARP investor wants a stock that’s not priced too high or too low, but one that is slightly priced lower that perhaps it should be and that also has good prospects for future growth– but not so much that the stock is overpriced or the future projections are too high.

You may like these posts:

  1. Stock investing strategy – Growth investing
  2. Stock investing strategy- Value investing
  3. Stock investing strategy-Fundemental investing

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