What is This Thing Called GARP?
Sandy Gallemore
Are you familiar with the term GARP? Investors hear the term frequently, but just what does it mean? Should you be a GARP investor? Why might GARP be a concept important to you?
GARP, a term made popular by Peter Lynch of Magellan Fund fame, along with Mario Gabelli, and David Dreman, means growth at a reasonable price. This is an investing strategy that suggests we invest in stocks with both growth and value potential. Warren Buffett chimes in with his view that "growth and value are joined at the hip." Investors look for stocks with higher than average earnings growth and lower than average price to earnings ratios. In other words, they want stocks that are reasonably priced when compared to the overall market. Typically, companies displaying GARP characteristics have strong overall fundamentals. The investor's goal is to avoid the extremes of both growth and value.
Proponents of the GARP strategy, sometimes referred to as a hybrid strategy, believe stocks that fit this description will be able to sustain themselves better than other stocks during tough times. In general, during bear markets these stocks tend to outperform high growth stocks, but tend to underperform pure value stocks. Some may consider these stocks a bit boring, and often they do not receive a great amount of attention from financial analysts. Those who tend to favor GARP stocks are rather conservative long-term investors.
How is GARP calculatedThe simple answer is: divide the current price to earnings ratio (PE) by the currently estimated annual growth rate of earnings per share (EPS). The result of this calculation produces a price to earnings to growth (PEG) ratio, which is the metric that calculates the balance between a given stock's value and its growth potential. The PEG ratio is a popular valuation tool used by investors to determine if the stock's price is appropriate for either a buy, hold, or a sell. A PEG ratio of 1.0 represents a fairly valued company. So, GARP investors look for PEG ratios under 1.0.
Many investors, especially those fairly new to investing, rely upon analyst consensus estimates (ACE) for projecting the annual EPS growth rate. Such estimates may be found at Yahoo. Type in your ticker symbol, and scroll down to Analysts Estimates. The Nasdaq website also includes earnings estimates. After inserting a ticker symbol, scroll to Analyst Research, then click on Forecast at the top of the page.
At Zackssimply insert the ticker symbol in the appropriate space for a quote and scroll to Estimates. Many brokerage websites also include links to earnings estimates. An extensive article about estimating earnings is available at Seeking Alpha. Keep in mind that most, if not all, of the earnings estimates available include estimates from some of the same analysts. So, comparing a few sets of estimates makes sense, but using more than two or three consensus estimates produce redundant results.
Estimating the future price of a stock is the other part of the calculation for GARP. The Yahoo website includes the one-year target price for a stock you include in a portfolio (assuming you check that as an option). After setting up a portfolio, click on Custom View, and select the options you want to see on your computer screen. An online search will reveal a number of articles giving a particular method for calculating future price.
An investor focusing on the GARP strategy would look for stocks with a price to earnings ratio (PEG) of no more than one. This reflects the PEG advice given by Peter Lynch. A PEG of one indicates the stock's PE ratio is in line with its expected earnings growth. A PEG of no more than one indicates the stock most likely is selling at a reasonable price. Our goal is to find companies that have sustainable growth potential, but currently are somewhat undervalued.
Typical GARP investors look for earnings growth to be 10-20 percent. Stocks with higher growth rates tend to be more risky and have more price volatility. GARP investors look for an investment comfort zone or middle ground between high growth stocks that can form bubbles and then crash quickly and value stocks that often go sideways for an extended time period. Criteria for screening for stocks meeting GARP standards are available at Fidelity. Note that definitions of each criterion are available and also that you are able to edit the criteria to meet your needs.
Investopedia article provides more information about the GARP investing strategy. Another interesting article about GARP investing is available at theShare Market School
Sandy is an InvestEd Inc. director and serves as vice president for education. She is lead editor and prepares the general program brochure for the InvestEd conference. Sandy, an O'Hara Award recipient, is a former member and president of a local investment club. She has helped form investment clubs, presented introductory investing programs, and taught stock study and mutual fund classes at local, regional, and national events. Sandy is professor emeritus, Georgia Southern University.
