Somewhere, investors got the idea they had to choose between growth stocks and value stocks. However, just like beer can be both great-tasting and less filling, there's a better strategy for those who want the best of both worlds.
Whether you call it fact, myth, or law, the original bad boys of investing, Benjamin Graham and David Dodd, laid it down as clear as crystal: Value investors should buy fundamentally sound stocks at bargain prices, and growth investors should buy stocks with solid growth prospects within a reasonable range of their intrinsic values.
For many investors, those are still the rules. But if you're ready to go beyond the confines of that framework, take a closer look at the concept known as GARP. It's probably one of the most logical investment strategies around.
Growth at a reasonable price
The idea of growth at a reasonable price, or GARP for short, was immortalized by Peter Lynch. It attempts to combine value and growth investing concepts into one solid strategy that -- when applied intelligently -- can make your net worth grow just as fast as some of the companies you'll invest in.
GARP looks exactly like it sounds. First, take stocks that have grown at a rapid rate in the past and look as if that growth will continue well into the future. Next, once you have a good list of candidates, compare their valuations and look for relatively cheap ones. For these purposes, I take a close look at the stock's PEG ratio. Although PEG ratios have their shortcomings and should never be your sole factor in picking a stock, they can give you a quick, surface-level look at valuation in comparison to growth expectations. Here are some stocks that came up in my screen results:
|
Stock |
PEG |
Past 5-Year Earnings Growth |
Next 5-Year Earnings Growth Estimates |
|---|---|---|---|
|
Diamond Offshore |
0.31 |
118% |
25% |
|
FLIR Systems |
0.75 |
31% |
20% |
|
GameStop |
0.46 |
54% |
14% |
|
Jacobs Engineering Group |
0.75 |
33% |
16% |
|
Precision Castparts |
0.68 |
46% |
14% |
|
SunPower |
0.70 |
90% |
32% |
|
Varian Medical Systems |
0.85 |
15% |
15% |
Source: Yahoo! Finance.
Of course, that analysis relies heavily on whether analysts' earnings projections are accurate -- and they may not be. But bear markets tend to punish even those stocks that aren't deserving of criticism. That creates bargains that you need to jump on quickly.
Beating pure value
If reasonable price is the key, however, why bother with GARP? The current market presents some amazing opportunities, as it's rather difficult to find stocks that aren't relatively cheap nowadays. So, why not just go with traditional value investing techniques and the stocks they usually turn up?
The reason is that market sentiment runs in cycles, and sometimes, traditional value stocks go out of favor. No one knows that better than value mutual fund managers who invested heavily in financials in recent years in the hopes of a quick rebound. Unfortunately, those stocks not only kept plummeting, but in many cases also slashed their dividends, removing nearly every positive attribute that made them attractive to value investors.
Remove the blinders
Of course, hindsight is 20/20, and plenty of folks were neck deep in financials when things hit the fan. But in the aftermath, there has never been a better time than now to be an investor. More companies than I've ever seen -- many with exceptional growth potential -- currently trade at attractive prices. It's almost like fishing a salmon run in six-inch water with a net, and there's no limit. Markets went from charging a premium for growth to discounting it in the span of a year.
Whatever you decide, the bargains are out there for the taking, and if you're going to practice true diversification, then you should diversify between growth and value stocks, because even if you have the most diversified portfolio on the planet, if all of your stocks are either growth or value-oriented, you could still be missing out. If you want to get the best of both worlds, GARP is the way to go.
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