GARP Investing Seeks a Middle Ground
|For some people, the world is an either/or. They exclusively drink either one soft drink or another. They’re a fan of either the Cubs or the White Sox. But what if you prefer to mix and match qualities of each option to approximate the best of both worlds? That’s essentially the idea behind an investment philosophy known as growth at a reasonable price (GARP). By combining aspects of growth and value investing — two common but often seemingly opposing investment styles — GARP can be a worthwhile strategy for investors who prefer to occupy a middle ground.
Attractive Valuation vs. Growth Prospects
To better understand how a GARP approach works, let’s review value and growth investing principles. The idea behind the value style is that you’re essentially looking for securities “on sale.” Value investors favor stocks whose intrinsic (or what they consider intrinsic) value is significantly higher than their current “low” market price. Value stocks may be companies that belong to an out-of-favor industry, such as homebuilders when the real estate sector is weak, or companies facing pessimism about their short-term business prospects, such as energy companies when oil prices are low.Meanwhile, growth investors tend to be less focused on valuation and more interested in a company’s ability to grow at a faster rate than the market expects. Many technology stocks fit this profile. Growth investors are willing to pay a premium today if they think the company will continue to grow at a rapid pace.
In the right hands, both value and growth investment styles can be effective ways to make money over the long term. But investors looking to balance the strengths of both approaches may find themselves attracted to the middle ground of a GARP strategy. For GARP investors, earnings growth is critical, and they’ll be drawn to companies with a track record of positive earnings growth and the prospect for that trajectory to continue. However, some of the fastest-growing companies are also the priciest. Hence, a successful GARP investor must be willing to consider companies that may be out of favor with some investors and thus come with lower price tags. This philosophy is neatly summed up by famed investor Warren Buffett: “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”
One of the challenges associated with GARP investing is that, because the strategy uses elements of both growth and value styles, it can be hard to determine which aspects to prioritize. To find companies with undervalued growth prospects, a GARP investor may rely on a variety of analytical measures. For example, price-to-earnings (P/E) or price-to-book-value ratios provide a window into how attractively priced a company is, based on factors such as its business performance and the strength of its balance sheet. Another common metric employed by GARP investors is price to earnings growth (PEG), which is the ratio between a company’s P/E and its expected future earnings growth. Unlike P/E, which is a snapshot of how a company is performing now, PEG helps investors assess whether a company’s current valuation is in line with its expected earnings growth. Thus, PEG potentially provides insight into a company’s value relative to its growth prospects.
Striking the Right Balance
Finding a strategy that combines the best elements of both growth and value investing can be worthwhile. However, remember that it’s possible to lose money in any type of investment. Your advisor can help you navigate such risks and use GARP strategies in the most effective way for your specific situation.