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Growth at Reasonable Price! - Views on News from Equitymaster
 
 
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  • Jan 5, 2007

    Growth at Reasonable Price!

    These are indeed difficult times for value investors. With the indices ruling at record highs, it is becoming increasingly difficult to come across companies that possess the twin virtues of good quality long-term earnings history and a share price, which is ruling well below its intrinsic value. Also, a lot of experts are of the opinion that focussing solely on statistically cheap companies may not give as good returns as was possible before, owing to increasing awareness and the speed at which information flows around the globe these days. The onus therefore is on companies that lie somewhere between the value and growth styles of investing, a style that is more commonly known as GARP, Growth at Reasonable Price.

    As mentioned earlier, Growth at Reasonable Price (GARP) is a mix of both growth and value investing. While a growth strategy is more focused on a company's earnings growth and value investing seeks companies having their prices below their intrinsic value, growth at reasonable price as a strategy, hunts for stocks that have both a growth potential and are also trading at a reasonable price. Thus, GARP investors make investments that lie in between those sought by growth and value investors.

    Investment process
    A typical GARP investor seeks to invest in companies that have had a positive performance over the past few years, and also have positive projections for the upcoming years. But because he is investing in between a value and growth style of investing, he will target companies that possess more realistic growth rates of 10% 20%, as opposed to a growth investor that targets 25% - 50% growth rates, as he perceives companies with higher growth rates as risky and unpredictable. To a GARP investor, a company having a high ROE relative to their industry average is an indication of superior performance.

    Valuation ratios- GARP investors will typically invest in companies that have a higher P/E than those, which will be picked by value investing. However, they do maintain P/E ratios lower than what a growth investor would deem fit.

    Like value investors, GARP investors too share an affinity for lower P/B ratios and perceive companies trading with a P/B ratio lower than the industry average as favourable investments.

    The PEG (Price/Earnings divide by annual EPS growth) is the most important ratio to a GARP investor as it helps him to gauge the difference between a stock's growth potential and its value. While they seek companies that have a PEG ratio more closer to 0.5, they interpret stocks trading below a PEG ratio of 1, as undervalued warranting a further analysis.

    GARP in practice
    Owing to the strategy employed by GARP, an investor is more likely to see his returns to be more stable than those of either a pure growth or value investor. In a dominant bull trend, it is the growth investor who will stand to benefit the most, followed by GARP and value investor. Whilst in a bear run the growth stocks will see larger erosion in their value than the GARP or value stocks. Thus irrespective of the market movements the GARP stocks have a tendency of yielding reasonable returns.

    Difference between various investment styles
    Style Advantages Disadvantages
    Value Investment value lower than intrinsic value Cheap stocks may remain cheap for ever
      Conscious of risk  
         
    Growth Investments made in Stocks with high earnings
    growth and high upside potential
    As earnings growth uesed for valuations is
    forward looking, it may not materialise
        Little attention is paid to price
         
    GARP Smoothend out returns May underperform pure growth stocks
    in sharply rising markets
      Attention is paid to price May underperform pure value
    stocks in sharply declining markets

    Conclusion:
    Having known about the various investment styles, one is often left wondering as to what investment style best suits them. While it may be difficult to lay down any defining rules for the same, it is more a function of an investor's risk taking appetite. An investor having a high-risk appetite is more likely to choose a growth strategy. However, an investor with moderate risk tolerance is more likely to show a preference for GARP or Value investing style. It is also more likely to be the case that while in value investing, one might miss a potentially good quality stock trading at reasonable valuations, one is more likely to spot the opportunity under the GARP style of investing. So next time you are in the midst of what looks like a prolonged bull run, do not forget to tweak your investment style albeit never at the expense of risking your capital.

     

     

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