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What Is Growth at a Reasonable Price (GARP)?

Growth at a Reasonable Price (GARP) is an investment strategy that seeks to identify companies exhibiting consistent earnings growth without excessively high valuations. This approach combines elements of both growth investing and value investing, aiming to find a middle ground between these often-contrasting styles. GARP investors look for businesses that are expanding their revenues and profits at an above-average rate but whose stock prices are not overly inflated relative to their future potential. The core philosophy of GARP is to achieve capital appreciation through growth while maintaining a discipline around valuation to avoid overpaying for a company's prospects.

History and Origin

The GARP investment strategy gained significant popularity through the work of legendary fund manager Peter Lynch. Lynch managed the Fidelity Magellan Fund from 1977 to 1990, achieving an impressive average annual return of 29.2%, consistently more than double the S&P 500 index over the same period.¹¹ During his 13-year tenure, the fund's assets under management grew from $18 million to $14 billion. Lynch's success was largely attributed to his GARP philosophy, which emphasized thorough research into individual companies and a focus on understanding their underlying businesses. His writings, particularly "One Up on Wall Street," further popularized this hybrid approach, making it accessible to individual investors.¹⁰

Key Takeaways

• Balanced Approach: GARP combines the pursuit of growth with a focus on reasonable valuation, seeking a balance between growth and value investment styles.
• Earnings Growth: GARP investors prioritize companies demonstrating consistent and sustainable earnings growth.
• Valuation Discipline: A key tenet of GARP is to avoid overpaying for growth, typically by assessing a stock's price relative to its earnings and growth rate.
• Quality Focus: Companies chosen for a GARP portfolio often exhibit strong financial health, competitive advantages, and robust Return on Equity (ROE).
• Long-Term Perspective: The GARP strategy is generally suited for investors with a long-term investment horizon, as it seeks to benefit from the compounding of earnings over time.

Formula and Calculation

A primary metric used by GARP investors to evaluate a stock's reasonableness is the Price/Earnings to Growth (PEG) ratio. This ratio assesses a company's Price-to-Earnings Ratio (P/E) in relation to its expected Earnings Per Share (EPS) growth rate.

The formula for the PEG ratio is:

Where:

• P/E Ratio: The current market price per share divided by the annual earnings per share.
• Annual EPS Growth Rate (%): The expected annual growth rate of the company's earnings per share, typically over the next one to five years. It is expressed as a whole number (e.g., 15 for 15% growth).

Interpreting the GARP

Interpreting the PEG ratio is central to applying a GARP strategy. A PEG ratio of 1.0 is often considered a benchmark, suggesting that a stock's valuation (P/E) is in line with its expected earnings growth.

• PEG Ratio < 1.0: This typically indicates that the stock may be undervalued relative to its growth potential. GARP investors often seek companies with a PEG ratio of less than one, as this suggests they are getting growth at a "reasonable" or even "cheap" price.
• PEG Ratio = 1.0: The stock's P/E ratio is considered to be fairly valued in relation to its growth rate.
• PEG Ratio > 1.0: This suggests the stock might be overvalued, as its price is high relative to its expected earnings growth. Pure growth investors might tolerate higher PEG ratios, but a GARP investor would likely avoid such a stock unless other compelling factors are present.

Beyond the PEG ratio, GARP investors also consider qualitative factors such as a company's competitive advantages, management quality, and the overall industry outlook to ensure the sustainability of its growth. This holistic approach aims to provide better risk-adjusted returns compared to strategies that focus solely on either growth or value.

Hypothetical Example

Consider two hypothetical companies, TechCo and MedCorp, for a GARP investor:

TechCo:

• Current Stock Price: $100
• Last Year's EPS: $5.00
• Expected Annual EPS Growth Rate (next 5 years): 25%

MedCorp:

• Current Stock Price: $60
• Last Year's EPS: $4.00
• Expected Annual EPS Growth Rate (next 5 years): 10%

Calculation for TechCo:

1. P/E Ratio = $100 / $5.00 = 20
2. PEG Ratio = 20 / 25 = 0.80

Calculation for MedCorp:

1. P/E Ratio = $60 / $4.00 = 15
2. PEG Ratio = 15 / 10 = 1.50

In this scenario, TechCo has a PEG ratio of 0.80, which is below 1.0. This suggests that TechCo might be a suitable GARP investment, as it offers strong expected growth at a reasonable price. MedCorp, with a PEG ratio of 1.50, appears overvalued relative to its growth rate from a GARP perspective, despite having a lower P/E ratio. A GARP investor would prioritize TechCo for its potential for capital appreciation without excessive market volatility due to overvaluation.

Practical Applications

GARP is a versatile strategy applied across various aspects of finance:

• Stock Selection: Individual investors and fund managers use GARP principles to screen for stocks. They analyze financial statements and other data to identify companies with a track record of consistent earnings and sales growth alongside palatable valuations. Sectors often favored by GARP investors include technology, consumer discretionary, and healthcare, where companies can exhibit strong growth potential.⁸, ⁹
• Mutual Funds and ETFs: Many mutual funds and exchange-traded funds (ETFs) explicitly follow a GARP mandate, providing investors with a diversified portfolio of GARP-oriented stocks. For instance, S&P Dow Jones Indices maintains the S&P 500 GARP Index, which aims to track companies within the S&P 500 that exhibit strong growth potential, reasonable valuations, solid financial strength, and robust earning power.⁶, ⁷ This index applies a multi-factor methodology, considering metrics like earnings per share and sales per share growth rates, along with quality and value attributes.⁴, ⁵
• Portfolio Management: GARP can be a core component of a well-structured portfolio, serving as a middle ground between aggressive growth and conservative value strategies. It contributes to overall diversification by blending characteristics that may perform differently across market cycles.
• Asset Allocation: For those engaging in strategic asset allocation, GARP-focused investments can offer a balance, potentially providing growth upside during bull markets while offering some downside protection due to their emphasis on reasonable valuations during market downturns.

Limitations and Criticisms

While GARP offers a compelling hybrid approach, it is not without limitations:

• Subjectivity of "Reasonable Price": A key criticism of GARP is the inherent subjectivity in defining what constitutes a "reasonable" price. This can vary significantly based on market conditions, industry, and individual investor outlook. What one investor considers reasonable, another might view as expensive, especially when relying on future growth projections.
• Growth Projections Risk: The GARP strategy relies heavily on accurate forecasts of future earnings growth. If a company fails to meet these growth expectations, the stock, even if reasonably priced initially, can underperform significantly. This risk is amplified because even "reasonably priced" growth stocks can decline if the broader market experiences a downturn.³
• "Value Traps" vs. "Growth Traps": GARP aims to avoid both pure "value traps" (cheap stocks with no growth prospects) and "growth traps" (high-growth stocks with unsustainable valuations). However, misidentifying either can lead to poor returns. A company might appear reasonably priced on current metrics but could be facing structural issues that limit future growth.²
• Data Dependence: Effective GARP investing requires robust financial data and analytical capabilities to calculate metrics like the PEG ratio and assess other quality factors. Investors must be diligent in their research to truly understand a company's fundamentals.
• Performance Variability: While academic studies suggest that GARP can be an effective strategy, its outperformance can depend on the observation period and market cycles.¹ During periods where pure growth or pure value strategies dominate, GARP may not always yield superior returns.

Growth at a Reasonable Price (GARP) vs. Value Investing

Growth at a Reasonable Price (GARP) and Value Investing are distinct yet related investment philosophies that often cause confusion due to GARP's emphasis on "reasonable price."

While value investors are primarily concerned with buying assets at a discount to their intrinsic value, often looking at statistically cheap companies, GARP investors are willing to pay a "reasonable" price for a company that demonstrates strong and consistent growth. The confusion arises because both strategies emphasize avoiding overpaying for a stock. However, a value investor might consider a company with modest or no growth if its current price is significantly below its calculated intrinsic value, whereas a GARP investor would prioritize a company with clear growth prospects.

FAQs

What kind of companies do GARP investors typically look for?

GARP investors look for companies that have a demonstrated history of consistent earnings growth and are expected to continue this trend into the future. They also seek companies that are not trading at excessively high valuations, meaning their stock price is reasonable relative to their growth prospects and financial statements indicate solid fundamentals.

Is GARP investing less risky than pure growth investing?

Generally, yes. By placing an emphasis on a "reasonable price," GARP aims to mitigate some of the risks associated with pure growth investing, where investors might pay very high valuations for companies based solely on future potential. The valuation discipline inherent in GARP can provide a greater margin of safety compared to aggressive growth strategies, potentially leading to lower market volatility.

Can GARP be applied to all types of stocks?

While the principles of GARP can be broadly applied, it is most commonly used for individual equity selection. It might be challenging to apply the exact PEG ratio metric to companies with negative earnings or highly inconsistent growth. However, the underlying philosophy of finding quality growth at a fair price can inform investment decisions across various sectors and market capitalizations.

How does GARP compare to dividend investing?

GARP focuses on capital appreciation driven by earnings growth, whereas dividend investing prioritizes regular income payments from a company's profits. While some GARP stocks may pay dividends, it is not their primary appeal. Dividend investors often look for mature, stable companies with a history of returning profits to shareholders, which may or may not exhibit significant growth.

Where can I find more information on GARP-related funds?

Many financial institutions offer mutual funds and index funds that adhere to a GARP strategy. You can typically find information on their investment objectives, holdings, and performance through their respective fund fact sheets or by searching financial data providers for funds categorized as "Growth at a Reasonable Price" or "Core" funds, which often incorporate GARP principles.