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GARP - Growth at Reasonable Price

As the year draws to a close it seems appropriate that we conclude our series on different investment styles. For those just joining the newsletter this column has covered the major investment styles (income, growth and value) looking at their principles, different securities types that can be used in pursuit of each style, and examples of each. While our selection is not exhaustive it provides a solid base with which to evaluate other styles. This week we conclude with Growth at Reasonable Price or GARP.

What Is GARP?
The GARP strategy is a combination of both value and growth investing: it looks for companies that are somewhat undervalued and have solid sustainable growth potential. The criteria for companies that qualify fall right in between those sought by the value and growth investors. GARP stocks are mid- range in terms of pricing and their growth prospects.

GARP strategy diagram
Source: ING

Growth prospects are assessed relative to value, with both earnings per share growth and different valuation ratios being used in the process. ING is an example of a manager that uses the GARP, another is Colonial First State. One of GARPs biggest supporters is Peter Lynch one of the world's best fund manager, partly due to his 29% average annual return over a 13-year stretch from 1977-1990. Like to know more read One up on Wall Street by Peter Lynch.

The Hybrid Characteristics
Like growth investors, GARP investors are concerned with the growth prospects of a company. They like to see positive earnings numbers over the past few years, coupled with positive earnings projections for upcoming years. But unlike growth investors however they are sceptical of extremely high growth estimates, such as those in the 25-50% range. They believe companies within this range carry too much risk and instead prefer companies with more realistic earnings growth rates in the 10 to 20% range.

Financial ratios:
Since there is no magic formula for confirming growth prospects, investors must rely on their own interpretation of company performance and operating conditions. However investors that use GARP use the following ratios to assist in identifying stocks with growth prospects and reasonable prices. As a starting point use the “stock picker” on your broker’s website using the ratios to screen for GARP stocks. Another good starting point is the investment research web site www.vaneyk.com.

Ratio / Indicators Multiple
PEG:  Price Earnings to Growth ratio 0.5<1.0
P/E:   Price to Earnings ratio 15-25
ROE:  Return on Equity High + increasing relative to industry average
P/B:   Price-to-book ratio Below industry average
Cash Flow Positive

Because a variety of additional criteria can be used to evaluate growth, GARP investors customise their stock picking system to their personal style. Exercising subjectivity is an inherent part of using GARP. So if you use this strategy, you must analyse companies in relation to their unique contexts with the main focus on present valuations.

Style Advantages Disadvantages
Value

Discounted price

Conscious of risk

Cheap stocks may remain cheap forever

Little attention paid to catalyst

Growth

Invests in earnings growth

Upside potential

Little attention paid to price

Earnings growth may not materialize

GARP Invests in catalyst that leads to higher stock prices

Smooth historical performance with less extremes

Attention to price

May under-perform pure growth in sharply rising markets

May under-perform pure value in sharply declining markets

Building and maintaining a portfolio based on GARP is easy once selection criteria have been determined. Using a spreadsheet with stocks linked to your favourite website or broker is one way to keep track of new buys and sells. Another and even easier way is to invest in a LMI that use GARP as their investment style. 

Listed managed Investments on ASX

Investment Styles
LMI Investment Area Style Comments
AFI Australian Equity Value biased, bottom up, yield focussed
ALR Australian Equity GARP, bottom up, leveraged
BEL International Equity Based on Constellation's HomeGlobal TM product
CFI Private Equity Australian Private Equity
DJW Australian Equity Value biased, some income generated through buy write strategies
GCA Asian Equity Value biased, bottom up ETFGCH
GCH Australian and Int Equity Style neutral, top down/bottom up, healthcare investment
MIR Australian Equity Emphasis on small caps
MLT Australian Equity Value biased, bottom up, yield focussed
SLF Australian Property Trusts Index Fund-replicates S&P/ASX200 Property Trust Index
STW Australian Equity Index Fund-replicates S&P/ASX200 Accum Index
SYL Australian Equity GARP/style neutral elements, bottom up
TGG International Equity Deep value, bottom up
WAB Hedge Fund Index Arb, Event Driven, Long/Short, Short Term Trading
WAM Australian Equity Growth bias, small cap bias, absolute return focus, active trader
WHF Australian Equity GARP/style neutral elements, bottom up
WIL Australian Equity Growth bias, small cap bias, buy and hold strategy
WIT Australian Equity Deep growth, bottom up, small to mid cap bias, concentrated portfolio
Source: Listed Managed Investments Review July 2005

Conclusion
With the major indices at or near record levels buying stocks poised for growth is not without its risks. As with all assets –equites, property, bonds buying at the right price is the difference between making money and potentially losing it. The recent past is littered with examples of prices that have overshot the mark. Given this very real possibility GARP principles have a role to play in all securities selection.

© All rights reserved 2004. This material is educational and it is not intended to constitute financial advice.

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