Growth at a reasonable price (GARP) investment strategy seeks to find companies that have strong earnings growth at a good price. GARP investment blends growth and value investing to create a better way to invest. How does it work?

As defined by Investopedia, “value investing is the strategy of selecting stocks that trade for less than their intrinsic value. Value investors actively seek stocks of companies that they believe the market has undervalued. They believe the markets overreact to good and bad news, causing stock price movements that do not correspond with the company's long-term fundamentals. The result is an opportunity for value investors to profit by buying when the price is deflated.”

So what determines value from an investor’s perspective? That usually depends on the perspective of the investor. Some look at current measures such as the Price/Earnings ratio (P/E) and other measures that focus on the current financial situation. Others look to future cash flows that are discounted at some rate to arrive at a value estimate based on future financial performance. The point of this analysis is to try to find stocks cheap in comparison to what they should be worth.

Although it is often said that growth investing and value investing are diametrically opposed, a better way to view these two strategies is to consider a quote by Warren Buffett: "growth and value investing are joined at the hip." Another very famous investor, Peter Lynch, pioneered a hybrid of growth and value investing with what can be termed as Growth At a Reasonable Price or GARP investment approach.

Mr. Lynch followed a set of rules when looking for growth and value or GARP investment opportunities. Here a are a few of his rules:

• They need to have a reasonably healthy balance sheet and are generating profits.
• The business should be relatively simple that can be easily understood.
• For the most part avoid the “hot” industries, and instead find those that are in the sectors that are out of favor.
• The PE ratio should be at or near the growth rate of the company.
• The growth rate should be accelerating.

So how does an investor, who recognizes that GARP investing is a rational way to invest, get started? The first thing to understand is just how efficient are the markets. When you sell a stock, somebody else believes in the stock and buys it. Conceptually, one of these investors is wrong about the stock. This is not always true, as one investor could be in for the short term and the other in for the long run and both can win. The investor selling might need the money for another investment. However, in many cases the market is being efficient and one investor is right and the other is wrong about the stock. So if you want to win most of the time, you want to structure things so you are on the right side of the trade.

Benjamin Graham was probably the first investor that fully understood this aspect of the market. That is stocks and markets can get oversold and present opportunities for value investors to get into quality companies for a low price. Not only do you want to look for cheap stocks, but you want to find the ones that are out of favor, the ones that no one else is considering. They might be boring or last year’s hot stock. The ones that people are ignoring yet have solid fundamentals and a special factor that can trigger renewed growth in the price of the shares. Psychologically people have shied away from these stocks so they have become oversold.

The questions a GARP investor needs to ask are where can I find the best opportunities and how can I get on the right side of the trend.? This isn’t just buying the cheap stocks that have a chance to move up based on statistical probability. A GARP investor is looking for companies that meet proven value assessment criteria and that offer the best potential for growth.

At Trading Online Markets, we search for quality companies that are out of favor, yet still possess good fundamentals and that offer a catalyst for growth. Basically, you want to find good bargains. As Bruce Greenwald, a Professor at Columbia says, “You also need to answer the question from the stand point of the market psychology. Why am I the only one looking at this stock? Is there something wrong with it, or does the market just not understand it?”

The search for growth at a reasonable price or GARP investment can use a number of criteria. The strategy is to look for good businesses that earn more relative to the price being paid than others. Then they look for a reason the company will grow their revenues and earnings more than is currently expected.

This approach leads us to such indicators as the return on capital employed ratio, earnings yield, and free cash flow yield. These and other indicators have proven useful to identify good companies that are growing and that are undervalued by the market.

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We include return on capital employed ratio and free cash flow yield as part of our evaluation of stocks under consideration for our model portfolios that have beat the market since our inception on January 2006. Give our four-week free trial to the Premium Membership a try. There is no risk, nor any obligation. If you have any questions regarding membership, please send an email to [email protected] and we will get right back to you. Your complete satisfaction is of utmost importance to us.