Investing with GARP - Growth at a Reasonable Price

December 8, 2020 Printer Friendly Printer Friendly

Introduction

GARP is short for Growth at a Reasonable Price. It is an investment strategy that combines the best of two worlds, growth and value, by finding growth companies which also sport reasonable valuations. GARP was popularized by Peter Lynch, the famous Fidelity Magellan Fund Investment Manager, who used GARP as the cornerstone of his investment strategy during his highly successful years as a Fidelity fund manager.

To celebrate the world according to GARP, we have added three GARP screeners to the library, one for each Stock Rover subscription level: Essentials, Premium and Premium Plus. And to make it easy to visualize the results produced by the screeners in the Stock Rover Table, we have also added three corresponding table Views to the library.

In this blog entry I will first discuss the GARP investment philosophy and then describe each of the three GARP screeners, all of which are available in the Stock Rover Investors Library.

So What Exactly is GARP?

The GARP strategy walks the line between pure growth strategies, which tend to be valuation insensitive, and pure value strategies, which tend to favor companies that are not growing or are not currently creating significant economic value. The basic idea of GARP is simple: growth is great, just don’t overpay for it.

One of the fundamental ways to evaluate the GARPinesss of an equity is via the PEG ratio, which is a measure of the company’s Price to Earnings ratio (P/E) divided by its growth rate. So, for example, if company XYZ had a current P/E of 15 and an earnings growth rate of 10%, its PEG would be 1.5.

There are actually two PEG ratios that can be used in Stock Rover: the Trailing PEG, which looks at actual past earnings, and the Forward PEG, which looks at forecasted future earnings. We will use both in our screeners.

From a GARP point of view, the lower the PEG number the better. In normal markets, a PEG of 1.0 or below would be a good starting point to find GARP candidates. However, this current market is anything but normal. With interest rates effectively at zero, stock market valuations are well above historical norms, as the market is one of the few places to go to get non-zero yields. This, in turn, means that in the current environment, PEG ratios well above 1.0 are still considered to land firmly in GARP territory.

Despite all this talk of PEG, please note that GARP is a lot more than just looking at PEG. This will become evident as I describe the details of GARP screening in Stock Rover.

The Stock Rover GARP Screeners

We have created three new Stock Rover GARP screeners. They are as follows:

  • GARP – Essentials
  • GARP – Premium
  • GARP – Premium Plus

Each screener can be imported into your account from the Stock Rover Investors Library. Essentials users can run the GARP Essentials screener. Premium users can run both the GARP Essentials and GARP Premium screeners. Premium Plus users can run all three screeners.

GARP Screeners

The Companion GARP Views

In addition to the three screeners, we have also created a companion View for each of the three screeners. Each View has the same name as the corresponding screener. Any of the new Views can be imported from the library into your account and added to the set of views you have available in your table. The following screenshot shows each of the three new Views in the Stock Rover Investors Library.

GARP Views

The GARP Essentials Screener

The GARP Essentials screener first looks at Forward and Trailing PEG, both of which must be under 1.5. Note that in the current market environment, using the preferred value of 1.0 would result in too few companies passing the screener, as market valuations are currently significantly above historical norms.

A good GARP stock should be growing sales at a reasonable clip and growing earnings faster than sales, which indicates efficiency in turning sales growth into profit. The criteria used by the GARP Essentials screener require that the Sales 1 year and the Sales 5 year annualized growth metrics both exceed 4%. Also, the screener requires that Earnings 1 year and 5 year annualized growth metrics both exceed 8%.

And to ensure that things still look rosy in the future, the screener requires that the estimated earnings for next year be projected to increase by more than 8%.

Beyond sales and earnings, the screener also requires that Operating Income growth over the last 5 years exceeds 8% per annum on average.

Finally, the P/E must be under 25, expressed as requiring an earnings yield of over 4%.

All of the the screening conditions for the Essentials screener can be seen in this screenshot below.

GARP Essentials Criteria

As of this writing, 21 companies pass the Essentials screener as shown below.

GARP Essentials Passing Companies

The GARP Premium Screener

The GARP Premium screener builds upon the GARP Essentials screener by adding in a key premium feature called Ranking. Ranking allows you to order the stocks that pass the screener by weighting the criteria used in the screener for importance. And then from the weighted criteria rankings, computing the overall rank. In this way, if say 50 stocks pass a screener, you will also see a ranking from 1 to 50 of those stocks based on the criteria you care about.

You can see how Ranking is used by viewing the Weights column as highlighted in the screenshot below.

GARP Premium Criteria

The GARP Premium screener also adds a few additional metrics that are available to Premium and Premium Plus subscribers.

The first of these is the Morningstar Growth Grade, which must be an “A” or a “B”.

Additionally, the Premium screener looks at the Sales and EPS quarter over quarter change, this year vs. same period last year for the most recent quarter. Passing companies need to show more than a 4% Q over Q sales gain and more than an 8% Q over Q earnings gain.

In the Premium Screener the stock selection universe is limited to US listings with a market cap over 250M. You can easily change this by updating the screener after you import it into your account if you prefer a different universe. This is highlighted by the arrow in the screenshot above.

As of this writing, 43 companies pass the Premium screener as shown below.

GARP Premium Passing Companies

The GARP Premium Plus Screener

The GARP Premium Plus screener builds upon the Premium screener by adding in two additional key Premium Plus features: the ability to access historical periods and the ability to write equations.

The Premium Plus screener utilizes these features by adding screening equations that ensure Sales, EPS and Operating Income have all increased in each of the last two years. Note this is a subtle difference from the annualized growth metrics used in the Essentials and Premium screeners, which do not ensure that each individual year in the period has increased. The equations ensure that we are seeing recent consistency of sales and earnings performance in our passing GARP companies.

The GARP Premium Plus screener also adds in additional criteria utilizing advanced metrics that are only available in the Premium Plus subscription level. Specifically, the following criteria are added:

  • The expected sales growth next year must exceed 2%
  • The expected EPS growth next year must exceed 4%
  • The margin of safety must exceed 5%
  • The industry growth decile must be in the top 40% for the company within its industry
  • The Stock Rover growth and value scores must both be in the top 50% of companies
  • The Price to Lynch Fair Value statistic is used in the rankings with a weighting of 10%
  • The 5 Year Growth Estimate is used in the rankings with a weighting of 5%

As of this writing, 18 companies pass the Premium Plus screener as shown below.

GARP Premium Plus Passing Companies

The top ranked company is Quidel which is involved in the development, manufacturing, and marketing of rapid diagnostic testing solutions. Below is a tooltip showing how Quidel did against the screener criteria, which helps you understand why it ranked #1 in the screener.

GARP Premium Plus Screener Tooltip

Summary

Growth at a Reasonable Price is a time-tested strategy that has performed extremely well over the long term. The strategy strikes a good balance between growth and value. Note that GARP will generally underperform growth and outperform value in a growth market; in a value market, the reverse is true – GARP will underperform value and will outperform growth. In mixed markets, GARP generally outperforms both growth and value.

Growth at a Reasonable Price is an excellent way to marry the best aspects of growth and value, while avoiding their worst characteristics, which for growth is overvaluation, and for value, is the lack of economic wealth generation by value companies.

Please note that any screener is just the beginning of the investment research journey, not the end. Companies that pass a given screener need to be further vetted via additional detailed research before any of them actually makes it to your buy list and potentially receives your hard earned capital.

We hope you download our new GARP screeners and use them to help you identify promising companies that embody the ideal of generating growth, but without having to overpay for that privilege.




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