How British American Tobacco Measures Up as a GARP Investment

LONDON -- A popular way to dig out reasonably priced stocks with robust growth potential is through the "Growth at a Reasonable Price," or GARP, strategy. This theory uses the price-to-earnings to growth (PEG) ratio to show how a share's price weighs up in relation to its near-term growth prospects -- a reading below 1 is generally considered decent value for money.

Today, I am looking at British American Tobacco  (LSE: BATS  ) (NYSEMKT: BTI  ) to see how it measures up.

What are British American Tobacco's earnings expected to do?

Metric 

2013

2014

EPS Growth

10%

9%

P/E Ratio

16

14.6

PEG Ratio

1.6

1.6

Source: Digital Look.

British American Tobacco has posted strong double-digit growth in four of the past five years, with last year's 6% expansion proving the exception, and the firm is expected to keep earnings rolling higher over the medium term.

At current prices, the firm's PEG reading registers above the benchmark representing good value, however. And the tobacco specialist's price-to-earnings (P/E) ratio is also running above the value benchmark of 10 for this period.

Does British American Tobacco provide decent value against its rivals?

Metric 

FTSE 100

Tobacco

Prospective P/E Ratio

17.1

14

Prospective PEG Ratio

4.8

2.2

Source: Digital Look.

British American Tobacco surpasses the FTSE 100 average in terms of both PEG and P/E ratings, and although it lags the broader tobacco sector when considering the latter reading, a superior PEG ratio illustrates the company's better growth potential.

At first glance, British American Tobacco would not appear to be a traditional GARP investment owing to a PEG reading above 1, even though the reading is not excessively high. Still, for those looking for reliable earnings growth over a long time horizon, I believe the firm is worthy of strong consideration.

Developing markets ready to drive earnings
British American Tobacco advised in last month's interims that revenues nudged 5% higher during the first quarter, although news of a 3.7% slip in cigarette volumes, to 160 billion sticks, concerned investors that demand may be waning for its products.

Even as enduring financial woes in Europe continues to hamper performance, I believe that the firm's revenues should continue to grow as off-take from emerging regions heads skywards. Demand from Asia-Pacific rose 6.7% on an annual basis to 48 billion sticks, the firm noted, and it is hiking its activities in these regions to cash in on these lucrative markets.

And helping to mitigate fears over reduced groupwide volumes last quarter, British American Tobacco advised that "the pricing environment remains strong," and the company is able to use its catalogue of marquee Global Brands -- namely Lucky Strike, Dunhill, Kent, and Pall Mall -- to maintain its pricing power and keep margins steady.

The firm is also tipped to launch its Vype e-cigarette technology in Europe in the next few months, according to recent reports from Sky News, giving it a strong foothold in another rapidly growing market.

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