By Philip Moskie

What is Growth Reasonable Price GARP? It is an investment strategy that seeks to identify companies with strong growth potential whose stock price is relatively cheap. The idea behind GARP is to balance the potential for growth with the risk of overpaying for a stock.  

Introduction to what is growth at a reasonable price (GARP)

Peter Lynch coined the term GARP in his book “One Up on Wall Street.” He was a famous mutual fund manager and author. Lynch managed the successful Fidelity Magellan Fund in the 80s. He found undervalued companies with strong earnings growth potential. His book popularized GARP as a common investment strategy. So lets understand what Growth at a Reasonable Price GARP?

Lynch’s GARP approach was an alternative to the traditional investment strategy of value investing, which focuses on finding companies that are undervalued based on their financial metrics, regardless of their growth potential. GARP combines elements of both value and growth investing by seeking to identify companies with strong earnings growth potential that are also undervalued by the market. 

In this post we will discuss what GARP is and how you can use it to start investing in a logic strategic manner. 

Advantages of Growth at a Reasonable price (GARP)

Growth at a reasonable price (GARP) is considered an important investment philosophy for several reasons:

Potential for Strong Returns:

By using the GARP approach, investors aim to achieve high returns by identifying companies with strong earnings growth potential and being undervalued. This strategy is particularly appealing for those seeking long-term growth.

Balancing Growth and Value:

GARP combines elements of both value and growth investing, which allows investors to balance the potential for growth with the risk of overpaying for a stock. This can help to minimize risk while still achieving strong returns.

Minimizing Overvaluation:

GARP emphasizes the importance of valuing a company based on its current stock price and financial metrics. This helps to minimize the risk of overpaying for a stock, which is a common problem among growth investors.

Long-term Investment:

GARP is a long-term investment philosophy that emphasizes the importance of ongoing research and monitoring to ensure that investments continue to meet GARP criteria over time. This can be especially beneficial for investors with a long-term investment horizon.

Flexibility:

GARP approach allows investors to be flexible, it can be applied to various sectors and industries, it’s not limited to a specific area, giving investors a broader range of options to choose from.

Adaptability:

GARP approach can be adaptable to the market conditions, if the market conditions are favorable for growth investments GARP investors can tilt their portfolio towards growth and if the conditions are favorable for value investing, they can tilt their portfolio towards value.

II. GARP Investing Basics

As we stated above, GARP allows investors to balance the potential for growth with the risk of overpaying for a stock. Let’s Review the first side, growth: 

Growth: How can we know if a company has strong growth potential? 

Factors	Description
Analyst Estimates	Look at analyst estimates for future earnings growth to provide insight into the company’s potential for future growth.
Industry	Consider the industry in which the company operates. Companies operating in growing industries may have more potential for growth than those in stagnant industries.
Management Team	Consider the company’s management team and their track record of driving growth.
Competitors	Research the company’s competitors and their growth prospects to have a better understanding of the company’s market position and potential growth.
Stock Price & Financial Metrics	Assess the value of the company based on its current stock price and financial metrics.
Risk	Balance growth potential with risk.

Value

How do we identify a company that has value? A GARP (Growth at a Reasonable Price) investor would be looking for a balance of growth and value when analyzing a company’s balance sheet. Some of the balance sheet items that a GARP investor may be looking for include:

Strong Cash Position:

Companies with a strong cash position, as shown on their balance sheet, may have the financial flexibility to invest in growth opportunities or to weather economic downturns.

Low Debt-to-Equity Ratio:

Companies with a low debt-to-equity ratio may be less risky than those with a high ratio, as they are less leveraged and have a greater ability to service their debt.

Solid Current Ratio:

A solid current ratio, which is current assets divided by current liabilities, indicates a company’s ability to meet its short-term obligations. A current ratio greater than 1 is considered healthy, as it means the company has enough current assets to cover its current liabilities.

High Return on Equity:

A high return on equity (ROE) indicates that a company is using its shareholders’ equity effectively to generate profits. GARP investors look for a strong and higher ROE than the industry average to identify superior stocks.

High Gross Margin:

High gross margin indicates a company has a good pricing strategy, ability to control costs and a good product or service.

High Operating Margin:

High operating margin indicates a company has a good efficiency in its operations and can control its costs effectively.

Target Investment Profile

Metrics	Description
Earnings Growth	Look for companies with a history of strong earnings growth, and projected growth between 5% and 20%.
Return on Equity (ROE)	Look for companies with a high return on equity (ROE) (industry)
Price-to-Earnings (P/E) Ratio	Use the P/E ratio to ensure that the companies they invest in are undervalued by the market.
Price-to-Book (P/B) Ratio	Use the P/B ratio to ensure that the companies they invest in are undervalued by the market.
Buy or Strong Buy Rating	Screen for stocks that have strong buy or buy ratings
Positive Cash Flow	Consider companies with positive cash flow.
P/E and P/B ratios less than the Industry Average	Screen for stocks that have P/E and P/B ratios lower than the industry average.

Risk:

Traditionally GARP investors see risk as one dimensional having to do with not overpaying for the stock. We believe that GARP investors must consider all risk. Here is a list of the types of risk you feel that you need to pay attention to when using GARP:

Risk Type	Description
Paying too much	The risk of paying too much for a company’s stock
Industry risk	The risk associated with the specific industry the company operates in
Company risk	The risk specific to the company, including management and financial stability
Outstanding issues	Any unresolved issues that may impact the company’s performance
Political risk	The risk associated with political factors, such as changes in laws or regulations
Economic risk	The risk associated with economic factors, such as recession or inflation

III. How to Implement a GARP Investment Strategy

For those investors that want to start to use a GARP oriented there is a lot of work to be done. Here is a step-by-step game plan for starting your journey

Start with industry segments

We believe that best place for you to start you trek into GARP is to study market industry segments. Look up what ETFs are available in different segments to track which areas of the market are doing well and which one’s aren’t. With that in mind, studying market segments can help clarify which areas are suitable for GARP investing. After identifying the desired segments, you can then find the stocks within that group and begin your research to find the best investment candidates.

Understand the current economic environment effects GARP

GARP is an investment strategy that aims to find companies that are growing at a faster rate than the market average but are trading at a reasonable price relative to their earnings and other financial metrics. The economic environment can affect the stock market and individual companies. During economic growth, companies may see increased revenue and profits, making it harder to find GARP opportunities. 

During recession, companies may see decreased revenue and profits, making it easier to find GARP opportunities. Different sectors of the economy may be affected differently. As a GARP investor, it’s important to keep an eye on the overall economic environment, the specific industries you’re interested in, and the monetary policy of a country.

Create a check list of GARP characteristics you are going to look for

You must define what a good investment looks like for you. What are the standards that you are going to adhere to? In other words, what are going to be the standards you are going to look for and finally decide based upon? The more you can clarify what you will look for and create a check list to analyze those companies, the better your results are going to be. You can compare the created profiles of your good investments to the profiles you created on your bad investments and learn what works and what doesn’t. 

Create systems for gathering, organizing, and analyzing your data

Creating a system for financial data collection and organization is crucial for investment success. Determine the necessary metrics, such as revenue, earnings, and cash flow. Research and compare data providers for reliability and cost-effectiveness. Set routines for data accuracy checks and explore automation options. Regularly assess the system’s performance and make adjustments as needed. By following these steps, you can improve data collection and make better investment decisions.

Pull the Trigger

Don’t fall into the “paralysis by analysis” trap. Once you have your system in place, start! You can start very small. The investment community has made it very easy for small investors to get into the market. Take advantage of this and get your money working for you.

Check your progress often

Once you have your plan, you need to make sure it is working. Even though you may be investing for the long run, you always have to stay aware of what is happening in your investment portfolio. 

Key Take Aways

• GARP is an investment strategy that aims to find companies with strong earnings growth potential, while at the same time are also undervalued based on their current stock price and financial metrics.
• GARP was popularized by Peter Lynch, who was the manager of the Fidelity Magellan Fund, one of the most successful mutual funds of the 1980s.
• GARP combines elements of both value and growth investing. In other words we are seeking to identify companies with strong earnings growth potential that are also undervalued by the market.
• GARP is considered an important investment philosophy for several reasons, including the potential for strong returns, balancing growth, and value, minimizing overvaluation, and being a long-term investment philosophy.
• GARP approach allows investors to be flexible, it can be applied to various sectors and industries, it’s not limited to a specific area, giving investors a broader range of options to choose from and adaptable to the market conditions.

Conclusion

GARP is an investment strategy that seeks to find undervalued companies with strong earnings growth potential. This approach balances growth with risk by considering stock price and financial metrics. Popularized by Peter Lynch, GARP is a widely used strategy with advantages like strong potential returns, balancing growth and value, minimizing overvaluation, and being a long-term investment philosophy. GARP allows for flexibility as it can be applied to various sectors and industries and can be adapted to market conditions. It’s crucial to conduct thorough research, continuously monitor investments, and adjust strategy as needed to make the most of GARP as a tool for long-term growth.