What are GARP Stocks?

24 Apr 2022  Read 1349 Views

Nothing in this world is perfect. Why else would there be a chink in every armour, a flaw in every plan? Yet perfection is wanted and people chase after it.

Based on the above overload of philosophy, it would be safe to assume that no singular investment strategy is perfect. No single strategy is an “end-all be-all” solution to your investment needs. As a result, investors tend to mix and match two or more investment strategies to get a personalised combination that fits their needs.

This combination benefits the investor in one of two ways. First can be by either bringing together the benefits of the strategies involved, such that these benefits outweigh the combined shortcomings. In the second way, one or both of the contributing strategies nullify the drawbacks of the other strategy in the combination.

One such combined investment strategy is known as GARP. GARP stands for growth at a reasonable price. GARP is an investing strategy that combines Value Investing and Growth Investing to give an investor “the best of both worlds” (Hannah Montana intensifies).

Thus, to better understand the GARP strategy, we need to understand Value Investing as well as Growth Investing first. So let’s get right to it.

Value Investing

Value investing is the stock market equivalent of discount shopping.

Suppose you go out to buy a product, any product. You are given the choice between a poorly made product at an affordable price, due to its poor quality, or a well-made product that is costlier than the low quality product but cheaper than the regular market price of the good itself. Which one would you choose?

Obviously the latter of the two wins. Yes, it’d be costlier than the low quality product, but the better quality at a lower than normal price makes the price difference worthwhile.

Well, value investing involves buying shares of companies that are fundamentally strong, i.e. they operate their business efficiently and effectively. Naturally, a by-product of this performance would be share prices that are more than say, penny stocks. Which is why you buy these shares when their prices are below their fair value due to market forces. As the market corrects itself, the share price will rise to its fair value and the investor will enjoy earning in the form of capital appreciation.

Value investing usually involves shares of companies that have existed for a long time and have established a strong market position by merit of their business operation.

Value investing also works on the assumption that the efficient market hypothesis is not applicable. This means that shares can be overvalued or undervalued because the prices are not reflective of all the market conditions and facts relevant to the share prices and investors aim to buy shares when they are undervalued.

Value investors seek to find the fair value or intrinsic value of the share they are interested in. While there are multiple fundamental analytics available at an investor’s disposal, Price-to-Book (P/B) Ratio, Price-to-Earnings (P/E) Ratio, and Free Cash Flow are some of the commonly used measures under this strategy.

Growth Investing

Growth investing is a strategy that involves generation of income by means of capital appreciation. This capital appreciation occurs because the company; whose shares are considered growth stocks, possesses new technology and services that help the operation of said business.

Access to newer technology and services affords the business an edge, which translates into higher earning potential for the business in relation to its peers in the industry or even the entire market. The increased earnings are usually not distributed among the shareholders, but are rolled back to the company’s capital itself to increase the resources that can utilise the improved technology and services.

Growth investing is opposed to value investing in two major ways. Firstly growth stocks usually belong to companies that are new and have high potential for growth due to possibly untapped markets. This makes these stocks a riskier bet than their value investing counterparts.

Another contrasting factor is that, due to their higher earning potential, growth stocks are often overvalued because of their high demand that is a result of the aforementioned potential. So, while value investing involves buying shares that are under their fair value, growth investing encourages buying shares that are above their fair value as the technological advancement may cause said prices to go higher still.

When it comes to growth investing, there are five key factors of the stock in concern that investors pay attention to. These metrics are, historical and future earnings growth; profit margins; Return on Equity; and share price performance.

GARP Investing

Now that we know the ingredients, let us see what the final dish looks like. GARP stocks are essentially growth stocks, with certain value investment stock filters applied to them.

This means that investors look for growth stocks to add to their portfolio. Value investing influences the stock selection process in terms of price of the share. Therefore, a GARP stock is an undervalued growth stock.

GARP investing does not lay down any boundaries in terms of metrics that investors need to look for while investing in shares of a company. One metric that is important under this strategy is the Price/Earning to Growth (PEG) ratio. Ideally the ratio should be less than 1 as this means that the price is in accordance to the growth of the business and not overvalued like growth stocks.

Filtered Goodness

LIke mentioned before, no investment strategy is perfect. So investors should not hold any of these aforementioned strategies on any unrealistic pedestals. The GARP investing strategy is a combined one that gained popularity due to its higher success rate than other combinations. This does not make any of the unpopular strategies any less useful or GARP a perfect filter.

Thus investors must always conduct their due research and apply or reject premade strategies as per their goals, appetites, horizons and many more factors.
Do you have any personal combinations of investment styles or strategies that you use and have found you success? Let us know in the comments section below.

Until then, happy investing.

About the Author: Deb P Samaddar | 233 Post(s)

Deb is a keen learner and eager to learn about the finance world. With an increased proclivity towards tech and language, he aims to capitalise on his interests as a content writer at Finology.

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