Growth at a Reasonable Price (GARP)

Growth at a Reasonable Price (GARP) is an investment strategy that combines qualities of both growth investing and value investing. The principle behind GARP is to find stocks that are anticipated to grow earnings at an above-average rate but whose valuations are still reasonable given their growth prospects. The GARP strategy helps investors balance the potentially high returns of growth investing with the risk mitigation of value investing by focusing on companies with solid growth potential that are not overvalued.

Fundamental Principles of GARP

1. Growth Metrics:
   • Earnings Per Share (EPS) Growth: Investors look for companies with a consistent and strong EPS growth, generally at a rate of 10%-20% per year.
   • Revenue Growth: Similar to EPS, revenue growth is another critical metric. Sustained revenue growth indicates that the company is successfully expanding its customer base and market reach.
2. Valuation Metrics:
   • Price-to-Earnings Ratio (P/E Ratio): Unlike pure growth investors who might ignore high P/E ratios, GARP investors are more cautious. They typically look for P/E ratios that are below the aggregate of their earnings growth rate.
   • PEG Ratio (Price/Earnings to Growth): GARP investors place significant importance on the PEG ratio, which adjusts the P/E ratio by accounting for the company’s growth rate. A PEG ratio under 1 generally indicates that the stock might be undervalued relative to its growth potential.
3. Other Financial Metrics:
   • Return on Equity (ROE): High ROE indicates efficient use of shareholders’ equity to generate profits.
   • Debt-to-Equity Ratio: A lower debt-to-equity ratio suggests that the company is not heavily reliant on debt to finance its growth.

Characteristics of GARP Companies

• Strong Fundamentals: GARP companies exhibit solid financial health, including robust earnings, revenue growth, and cash flow.
• Competitive Advantage: These companies typically possess a sustainable competitive advantage, which could be through intellectual property, brand reputation, or unique products.
• Moderate Valuation: Reasonable P/E and PEG ratios that suggest the stock is not overly expensive relative to its earnings growth potential.

Advantages and Disadvantages of GARP

Advantages:

• Balanced Approach: The GARP strategy aims to balance high growth potential with reasonable valuations, thereby potentially reducing risk while still achieving significant returns.
• Flexibility: GARP investors can adapt their portfolios in both bullish and bearish markets by selecting companies that fit the GARP criteria.
• Risk Mitigation: By avoiding overly expensive stocks, GARP investors mitigate the risk of significant price corrections.

Disadvantages:

• Limited Universe: The GARP criteria can significantly narrow the pool of suitable investments, making it challenging to diversify.
• Subjectivity in Valuation: Determining what constitutes a “reasonable” price can vary among investors, leading to potential subjectivity and inconsistent results.
• Potential for Underperformance: In a growth-oriented bull market, GARP strategies might underperform pure growth strategies as they include valuation constraints.

GARP vs. Other Investment Strategies

1. GARP vs. Growth Investing:
   • Growth investing focuses solely on companies expected to grow earnings at an above-average rate, often disregarding high valuations.
   • GARP introduces valuation metrics, ensuring that the investments are not excessively priced relative to their growth potential.
2. GARP vs. Value Investing:
   • Value investing targets undervalued stocks based on fundamental analysis, without necessarily prioritizing growth prospects.
   • GARP merges value investing principles with a focus on companies exhibiting strong and stable growth.
3. GARP vs. Dividend Investing:
   • Dividend investing targets companies that pay high and consistent dividends, often associated with more mature, lower-growth companies.
   • GARP typically does not prioritize dividend yield; instead, it focuses on earnings and revenue growth combined with reasonable valuations.

Famous GARP Investors

• Peter Lynch: Perhaps the most famous GARP investor, Peter Lynch managed the Fidelity Magellan Fund from 1977 to 1990 and achieved an average annual return of 29.2%. He famously looked for “tenbaggers,” stocks that would go up tenfold, while still trading at reasonable valuations. Lynch also popularized the PEG ratio.

GARP Screening Criteria

To identify potential GARP investment opportunities, investors can use the following screening criteria:

1. EPS Growth: Companies with historical and projected EPS growth rates of 10%-20%.
2. P/E Ratio: Stocks with P/E ratios lower than the overall market or below the earnings growth rate.
3. PEG Ratio: Targets a PEG ratio below 1.
4. ROE: Preference for companies with ROE above 15%.
5. Debt-to-Equity Ratio: Typically, a debt-to-equity ratio of less than 50%.

Real-World Application of GARP

Case Study: Apple Inc. (AAPL)

• In the early 2000s, Apple was a classic GARP stock. Despite strong growth prospects with innovative products like the iPod and later the iPhone, Apple’s valuation remained reasonable for a long time.
• Growth Metrics: Apple exhibited substantial EPS and revenue growth due to its product innovations and expanding market share.
• Valuation Metrics: Despite the growth, Apple’s P/E ratio was relatively modest compared to high-flying tech stocks at that time. The PEG ratio remained attractive, indicating a balance between growth and value.
• Performance: Investors who recognized Apple as a GARP candidate experienced substantial capital appreciation as the company continued to innovate and expand its market presence.

Key Takeaways for GARP Investors

1. Diversification: While the GARP strategy narrows the investment universe, it’s crucial to diversify across different sectors to mitigate sector-specific risks.
2. Continuous Monitoring: GARP investors must continuously monitor their investments to ensure that companies maintain their growth trajectories and valuations remain reasonable.
3. Long-term Focus: GARP typically requires a long-term investment horizon, as the strategy relies on compound growth over time.

Conclusion

The Growth at a Reasonable Price (GARP) strategy offers a balanced approach that combines the best aspects of growth and value investing. By focusing on companies with strong growth potential that are still reasonably valued, GARP provides a framework for potentially high returns while managing investment risk. Investors who apply GARP principles rigorously can identify promising investment opportunities and achieve sustainable long-term growth.

For more information about GARP investing strategies, you can visit reputable investment company websites, such as:

• Fidelity Investments
• T. Rowe Price