There are a lot of benefits that one could get by applying certain strategies in investing. Some may prefer stocks that are bought at a discounted price, while others may want to secure profits from growth stocks regardless of their current price. Recently, we have talked about growth and value investing strategies. But how about investors who like the ideas presented on both strategies, but don’t want to consider some of their concepts? In this article, we are going to talk about a hybrid investment strategy called GARP.
What is GARP?
There are some investors who argue that growth and value investing should not be separated. GARP simply means growth at a reasonable price. It is literally a hybrid investment strategy that seeks balance of both growth and value investing. This investment strategy seeks stocks that are believed to have the potential to deliver above-average growth in a relatively low price range. It emphasizes picking investments that are slightly undervalued, but still expect to grow consistent earnings in the coming years.
GARP investing was widely popularized by Fidelity manager Peter Lynch after he had an average return of 29% from 1977-1990 by using the strategy’s fundamentals. It is not like growth investing, which only aims to buy growth stocks regardless of the price because they think it would still grow more than that.
GARP eliminates the risk of buying high priced securities in the hopes of high growth. It focuses more on older companies with consistent growth rates that trades at a reasonable price at the same time.
GARP investors are not necessarily looking for bargain investments or expensive growth stocks; instead, they are more interested in stocks with potential for realistic and attainable growth while also looking for slightly undervalued stocks.
How to compute for the GARP
The formula for finding GARP is by computing the price/earnings growth ration (PEG). This ratio divides the company’s current P/E ratio by the earnings growth rate. It is designed to measure the balance between growth and the valuation of the company. The ideal PEG ratio is one or less, but based on studies, a PEG closer to 0.5 is considered the best.
The main objective of this strategy is to select companies that have both low relative P/E ratios and high EPS growth rates. In bear markets, stocks selected through GARP strategy are said to outperform both pure growth and value investing stocks.
Why choose GARP?
GARP seeks to avoid the disadvantages brought by using pure growth and pure value investing strategies. Growth stocks can result to a bubble in stock value, which can eventually pop and crash in an instant. Value investing, on the other hand, can go nowhere for a very long time and may even go against the predictions of the investor if calculations are not done properly, similar to investing in penny stocks.
Through GARP, investors find the middle ground of both strategies. They can seek to enjoy rising prices without being too vulnerable to a sudden price crash. It may usually underperform growth stocks in a growth market and value stocks in a value market, but it can also outperform both in mixed markets and over the longer term.
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