If stocks weren’t expensive at the end of 2012, they certainly were at the end of last year. The Vanguard S&P 500 ETF (NYSE:VOO) nearly 34% gain in 2013, pushed many sectors above their historic average price to earnings metrics.
That’s causing some uneasiness among investors- especially considering some economic data hasn’t been entirely too bullish as of late.
To put it bluntly, there is a general fear from most investors about overpaying for U.S. stocks. Unlike during the dark days of 2009- when almost all stocks were at super bargain levels- today it's becoming much harder to determine what makes a good buy versus a poor one.
Luckily, portfolios can take advantage of an investment style that attempts to bridge the gap between finding value and growth.
Getting To Know GARP
Given just how many years the market has surged upwards since the end of the Great Recession, stocks may no longer be considered cheap. Since the 1850’s, the stock market has traded at an average price-to-earnings ratio of about 15. Today, that number sits closer 18. While that doesn’t suggest bubble territory just yet, it does mean that things are getting to be a bit frothy in stock-land.
Which is why investors may want to consider using a growth-at-a-reasonable-price or GARP strategy going forward.
First popularized by famed superstar manager Peter Lynch at Fidelity’s Magellan Fund (FMAGX), the investing style tries to blend both traditional value and growth investing styles under one roof. Essentially, proponents of GARP investing will screen for companies that are showing consistent earnings growth above broad market levels as well as look for stocks trading at low valuations.
During his tenure at Magellan- from 1977 to 1990- Lynch used the technic to average an insane 29% annual returns. Another well-known fan of the GARP investing style is Berkshire Hathaway’s (NYSE:BRK-A, BRK-B) Warren Buffet. Buffet views GARP as the only real investing style and has said that "growth and value investing are joined at the hip." We all know his record on investing success.
For us home-gamers, using a GARP strategy can be actually quite simple to implement.
The price to growth ratio (PEG) is a measure of a company's P/E ratio and its expected earnings growth rate over the next few years. Followers of strategy usually point to this one metric as the key to finding quality GARP candidates. The lower the PEG the better- with a score of 1 showing that P/E ratios are in line with expected earnings growth. PEGs less than 1 show that the stock is cheap relative to its potential growth.
Making A GARP Play
With stocks simply not as cheap as they once were, finding good growth at cheap prices is becoming more important than ever. For investors, GARP can be the go to strategy.
And the new iShares MSCI USA Quality Factor ETF (NASDAQ:QUAL) could be the go to broad play. The ETF screens for firms that high return on equity, stable year-over-year earnings growth and low financial leverage. Basically, it’s as much of GARP play as you can get in a broad package. QUAL’s screens produces a portfolio 126 different firms including Google (NASDAQ:GOOG) and payment play Visa (NYSE:V). Expense for the fund are a cheap 0.15%. Likewise, the PowerShares Fundamental Pure Large Core (NASDAQ:PXLC) and Barron's 400 ETF (NASDAQ:BFOR) use similar screens to create broad GARP-like portfolios.
For investors wanting to go the D.I.Y approach, running a simple stock screen with low PEG and P/E ratios can be the starting point for further research.
A prime GARP play could tech’s reigning champion -Apple (NASDAQ:AAPL). As a GARP stock, Apple fits all the right metrics. With a current P/E of around 13, shares are certainly cheap. Contrast that with fellow tech darling Amazon (NASDAQ:AMZN) and its P/E of 605. Yet, investors are only paying peanuts for that growth. AAPL shares currently have a PEG of 0.65. With its abundant cash flows, rising sales in emerging markets and innovation, Apple could be seen as the ultimate growth-at-a-reasonable-price stocks.
The Bottom Line
With the broad market hitting new highs, stocks aren’t as cheap as they once were. That’s were GARP style investing can come in. Bridging both growth and value investing, GARP is the best way to find cheap growth in the rising stock market. The previous ideas are just some of the prime picks in the style.
Disclosure - At the time of writing, the author did not own shares of any company mentioned in this article.