Value investing and growth investing are not too distinct disciplines. Rather, they are joined at the hip. Any serious value investor understands that value is created by growth. The difference is that "value" investors avoid overpaying for that growth. Paying little for that growth creates an undervalued investment. A business that can grow its intrinsic value by 10-15% may be considered an undervalued investment even if the investor buys at 80% of intrinsic value. Over time, the growth in intrinsic value creates a bigger margin of safety.
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An often-used acronym to describe such cheap stocks is GARP, which stands for Growth At a Reasonable Price. Such businesses may not trade at wide discounts to book value or low P/E ratios, but instead the underlying business offers an attractive growth profile relative to the current valuation. In fact, most value-style investments today actually qualify as GARP-style investments. Unless one is investing in a liquidation or special situation opportunity, growth is what creates value. Of course, the key is not paying too much for such growth. Amazon.com (Nasdaq: AMZN) is a high-growth, profitable business, but at current prices investors are too excited about that growth. The stock trades at 52 times earnings - an incredibly generous valuation for any business.
On the other hand, a name like Forest Labs (NYSE: FRX) fits the bill. The shares trade at 12 times earnings, and shares are in a lull due to the looming patent expiration of its blockbuster Lexapro. Despite accounting for a majority of revenues, Forest currently has nearly 20 new drugs in its pipeline. The odds are quite good that a few of them will succeed. In the meantime, this uncertainty has created an attractive price. Shares trade for $27, including $11 in cash per share, and no debt. (For related reading, check out Stock Picking Strategies: GARP Investing.)
Other names fitting the bill that would make for good investigation include giant industrial construction firm Fluor (NYSE: FLR). It's an $8 billion company with nearly $2 billion in net cash. Its worldwide operations in a wide array of industries give the company a great future. A much smaller but equally intriguing construction business is Sterling Construction (Nasdaq: STRL), a $230 million company that focuses on municipal construction projects primarily in Texas and Nevada. State budgets today don't bode well for Sterling, but the company has a pristine balance sheet and exceptional management that is willing to wait until contract pricing improves.
Growth is valuable because it is not easy to do year in and year out. When looking at GARP-type companies, it's important to have realistic growth expectations. Assuming a business can grow at unrealistic rates for prolonged periods of time will make any company seem attractive. Unfortunately, such lofty expectations often lead to expensive mistakes. (For related reading, check out The 3 Most Timeless Investment Principles.)
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