GARP strategy explained: A mix of growth and value investing

Popularized by legendary Fidelity manager Peter Lynch, Growth at a Reasonable Price (GARP) is a well-known, much-practised investment approach. This strategy balances both growth and valuation as growth investing tends to pick high-growth but expensive stocks, while value investing tends to take a long-term investment to pay off. The overarching goal while employing the GARP strategy to investing is to avoid the extremes of either growth or value investing; this typically leads GARP investors to pick stocks that are growth-oriented with relatively low price/earnings (P/E) multiples in normal market conditions. 

As the GARP strategy is a hybrid solution that mixes growth and value-stock picking, an investor that employs such an approach will get a combination of returns. For example, while a value investor will do better when markets are falling, and a growth investor do better when markets rise – a GARP investor will more often than not be somewhere in the middle. 

Mechanics of GARP investing 

While the GARP investing approach may not have rigid boundaries for including or excluding stocks, a fundamental metric that serves as a solid benchmark is the price/earnings growth (PEG) ratio. The PEG shows the ratio between a company's P/E ratio (valuation) and its expected earnings growth rate over the next several years. A GARP investor would seek out stocks that have a PEG of 1 or less, which shows that P/E ratios are in line with expected earnings growth. 

Let us assume a share is trading at Rs 100 with earnings per share (EPS) Rs 10, which is expected to grow at 15% over the next year. So, P/E ratio (current market price / earnings per share)= Rs 100/Rs 10 = 10 and PEG ratio (P/E ratio / annual EPS growth) is = 10/15 = 0.66. Thus PEG which is less than 1, makes this company a good candidate for GARP. 

By employing a strategy, investors can look for companies with solid growth prospects and current share prices that do not reflect the intrinsic value of the business. So they are getting a double play as earnings increase and the price/earnings (P/E) ratios at which those earnings are valued also increase. 

Advantages 

Growth stocks could be volatile and may fall as fast as they climb. Investors who follow the trend blindly and buy in the latter part of the rally might lose significant amounts. Meanwhile, Value stocks could take a long time to see share price appreciation. By balancing value and growth, GARP shares demonstrate both good earnings and growth potential while being not as overpriced.