Growth at a Reasonable Price (GARP)

Growth at a Reasonable Price (GARP)

Growth at a Reasonable Price (GARP) is an equity investing approach that blends elements of growth and value investing. It targets companies with above-average, sustainable earnings growth while avoiding those with excessively high valuations. The aim is to capture growth upside without paying speculative premiums.

How GARP works

• Focus: Companies with consistent earnings growth that are not overpriced.
• Core metric: Price/Earnings-to-Growth (PEG) ratio. PEG = (P/E) ÷ (expected annual earnings growth rate).
• Rule of thumb: PEG ≤ 1 suggests the stock’s price is in line with expected growth; PEG > 1 may indicate overvaluation relative to growth expectations.
• Example: P/E = 20 and expected growth = 20% → PEG = 20 ÷ 20 = 1.
• Practical approach: Look for firms with steady revenue and earnings growth, solid balance sheets, and reasonable P/E multiples relative to growth prospects.

Origins and context

• The GARP style was popularized by managers such as Peter Lynch.
• It occupies a middle ground between pure growth investing (prioritizing high growth even at steep valuations) and strict value investing (prioritizing low valuations and margin of safety).

GARP versus other styles

• Growth investing: Seeks rapid revenue and earnings expansion; often tolerates high P/E ratios. Can be vulnerable in downturns when growth expectations are cut.
• Value investing: Seeks stocks priced below intrinsic value, emphasizing margin of safety; often uses discounted cash flow (DCF) and other valuation methods.
• GARP: Attempts to harvest growth while keeping valuation discipline, potentially offering better downside protection than pure growth approaches but typically less extreme bargains than deep value strategies.

Implementing GARP

Options for individual investors:
– Index/ETF approach: Use funds that follow a GARP index to gain diversified exposure without stock-by-stock analysis.
– Example: The S&P 500 GARP Index screens for steady growth, reasonable valuation, and financial strength. Some ETFs track this index (one example invests most of its assets in the index and has an expense ratio around 0.36%).
– Typical sector exposures in GARP-focused funds often tilt toward healthcare and information technology, with meaningful allocations to financials and smaller weights in consumer staples and communication services.
– Stock-picking approach:
– Screen for companies with PEG ≤ 1 and consistent multi-year earnings growth.
– Evaluate fundamentals: revenue trends, profit margins, cash flow, debt levels, and competitive position.
– Consider macro and industry prospects that support continued earnings growth.

Pros and cons

Pros:
– Balances growth potential with valuation discipline.
– May offer better downside resilience than pure growth strategies during market corrections.
– Disciplined use of PEG and other metrics helps avoid speculative overpaying.

Cons:
– Reliance on analysts’ growth estimates can introduce forecasting risk.
– May underperform strict value strategies in deep bear markets where low-P/E bargains dominate.
– PEG is a simplification and should be used alongside other financial analysis.

Key takeaways

• GARP seeks companies with above-market earnings growth priced at reasonable valuations.
• The PEG ratio is a central tool; a PEG of 1 or less is a common screening threshold.
• Investors can implement GARP through targeted ETFs or by screening for PEG, consistent growth, and healthy fundamentals.
• GARP offers a middle path between growth and value, aiming for growth exposure with valuation discipline to moderate downside risk.