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The Market According To GARP
Posted: Jun 27, 2008 13:33 PM by Will Ashworth
GARP stands for growth at a reasonable price. It's a strategy combining value and growth investment attributes when selecting individual stocks. One of the greatest proponents of the strategy is Peter Lynch, the now retired long-time portfolio manager of the Fidelity Magellan fund. When he stepped down from everyday investing in 1990, he'd used the strategy to achieve annualized returns of 29% over a 13-year period.
The key statistic for any GARP investor is the PEG ratio, defined as price to earnings (P/E) divided by earnings growth (G). Most use the current P/E and a projected earnings growth rate for the next five years. If the ratio is less than 1, the stock is a good value candidate. However, other investors look for greater value in their stocks and a ratio of 0.5 or less. (To learn more about the PEG ratio, check out PEG Ratio Nails Down Value Stocks.)
While the PEG ratio is the most important to GARP investors, another useful one is price to book (P/B). This examines how the market values a company's assets. If the ratio is high, the market feels the assets are worth more than their value on the balance sheet and if it's low, the opposite is true. If the P/B is less than the industry average for its category, it's a good buy.
In addition to the PEG and P/B ratios, GARP investors also like P/E ratios that are between 15 and 25, a high return on equity (ROE) and return on investment (ROI) that are increasing relative to the industry average and lastly, positive cash flow. All of these combine to produce long-term returns with lower risk. When markets are rising, GARP stocks generally under perform, and when markets are falling, they tend to do better than average. (Read more about the GARP ratio in Stock-Picking Strategies: GARP Investing.)
GARP Standouts
| Company |
PEG |
Market Cap |
ROI |
Operating Margin |
Focus Media
(Nasdaq:FMCN) |
0.35 |
$3.83B |
11.4 |
30.70 |
CTC Media
(Nasdaq:CTCM) |
0.69 |
$3.86B |
25.2 |
29.92 |
New Oriental Education
(NYSE:EDU) |
0.89 |
$2.30B |
17.76 |
27.12 |
DreamWorks Animation
(NYSE:DWA) |
1.20 |
$2.84B |
19.62 |
24.52 |
RRSat Global Communications
(Nasdaq:RRST) |
0.73 |
$216M |
16.46 |
18.94 |
ITT Educational
(NYSE:ITT) |
1 |
$2.81B |
87.33 |
18.51 |
Choice Hotel International
(NYSE:CHH) |
1.5 |
$1.93B |
90.17 |
17.87 |
International Game Technology
(NYSE:IGT) |
1.43 |
$9.68B |
14.19 |
17.04 |
Harley Davidson
(NYSE:HOG) |
1.20 |
$9.21B |
27.04 |
15.87 |
Apollo Group
(Nasdaq:APOL) |
1.46 |
$8.77B |
53.43 |
15.22 |
| Data as of market close June 13, 2008 |
Top Picks
Harley Davidson
Harley's been making motorcycles for over 100 years. It is America personified. Soon it could be the biggest and best leisure brand worldwide, but first it needs to traverse some bumpy roads. In April, Harley Davidson announced revised EPS guidance for fiscal 2008 of $3.00-3.18 per share; this is down 15-20% from $3.75 in 2007. Only three months earlier, in its year-end earnings release, Harley said EPS would increase between 4% and 7% in 2008. Why the change? The U.S. market for motorcycles and other expensive gasoline powered vehicles has cratered as consumers seriously reassess their spending.
Not to fear, since 2003, it’s averaged 15% annual EPS growth. In fact, between 1994 and 2007 it increased EPS 13 out of 14 years, with 2007 the exception. In that 14-year period, sales went from $933 million at the end of 1993 to $5.72 billion in 2007. That's a CAGR of 13.83%. Harley's going to be rolling down the highway for another hundred years.
DreamWorks Animation SKG
DreamWorks Animation develops computer generated animated feature films like "Shrek", "Madagascar" and "Bee Movie". It was a part of DreamWorks Studios until October 24, 2004 when it became its own publicly traded company. DreamWorks Studios opened for business in 1994 with industry executives Steven Spielberg, David Geffen and Jeffrey Katzenberg at the helm and is now owned by Viacom (NYSE:VIA.B).
Last year was a good one, with "Shrek The Third" and "Bee Movie" bringing in over $767 million in revenue and $291 million in operating income in just seven months. The company makes only two films a year, so it's important that they all do well at the box office. That doesn't always happen, so any investment should be long-term.
Conclusion
Stocks that are growing and reasonably priced combine the best attributes of value stocks and growth stocks into what is termed GARP or growth at a reasonable price. These opportunities can be more difficult to spot than a straight growth or value play, but they are worth the effort. The list above should provide a good starting point for potential GARP converts.
To read more on strategies for choosing the best stocks, see our Guide to Stock Picking Strategies.
By Will Ashworth
Will Ashworth lives and works in Toronto, Canada. He's worked in and around the financial services industry for much of his adult life. He loves investing and is passionate about helping others learn how to put their money to work.
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