The Stock Market According To GARP

By Aaron Levitt | May 25, 2010 AAA

With the market whipsawing back and forth and volatility returning to the forefront, investors these days are facing a quandary. While the global economy, as a hole, seems to be getting better, problems from Europe have added unintended increased risk to portfolios. Unlike 2009, when almost all assets were at super bargain levels, today it's becoming much harder to determine what makes a good buy versus a poor one. Luckily, investors do have an investment style that attempts to bridge the value and growth gaps.

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John Irving's Stock Play
Aside from the title of a John Irving novel and subsequent movie, GARP or growth at a reasonable price investing was first popularized by famed manager Peter Lynch. The investing style in efforts to form the growth/value blend looks for companies that are showing consistent earnings growth above broad market levels (a tenet of growth investing ) while excluding stocks that have very high valuations (value investing). While not as rigid as some forms of investing, GARP followers usually point to one metric in their quest to find stocks. The price to growth ratio or PEG is a measure of a company's P/E ratio and its expected earnings growth rate. For GARP investors, lower PEG is better. (Learn more about PEG, see: Move Over P/E, Make Way For The PEG.)

As the market swooned upwards nearly 67% in 2009, GARP investors underperformed slightly. Most managers following the style shun high debt loads, but with many high debt companies priced at ultra cheap levels, they rose more than conservative growth-value picks. If the market surges upwards intensely again, GARP may flounder. Traditionally, GARP stocks, such as Microsoft (Nasdaq: MSFT) aren't particularly exciting, but represent growing, cash flow heavy businesses. But, if we float sideways for awhile, which most analysts are predicting, GARP could be a superstar strategy.

The Portfolio Plays
One of the easiest ways for investors wanting to implement a GARP strategy for their portfolios is to look at both value and growth exchange traded funds and see what stocks intersect. The iShares Russell 1000 Growth Index Fund (NYSE: IWF) and iShares Russell 1000 Value Index Fund (NYSE: IWD) both have many firms that are included in each style ETF. For example both funds include investment in Procter & Gamble (NYSE: PG). Investors can then look at the PEG ratios of the overlapping firms to determine great GARP targets. Here are a few picks.

Shares of Walt Disney (NYSE: DIS) currently trade for less than they did in 1998, yet the company is earning far more revenue than it did back then. The company is also poised to benefit from the growth of content for mobile devices. Analysts predict that we'll be watching more television and reading more from our smartphones in the upcoming years ahead. This growth is a boon for content providers such as Disney as it has many avenues it can tap including its investments in ESPN and ABC. Shares of the company trade at a PEG ratio of 1.73.

Trading at a PEG of nearly one, consulting firm Accenture (NYSE: ACN) represents a classic GARP play. As the economy rebounds, more companies will use Accenture's services adding to its revenues. Accenture's main asset is its employees and it has very little CAPEX spending. The margins for its work can continue to supplement its $4.11 billion in cash.

Knight Capital Group (NYSE: KCG) represents a deep GARP play with a PEG of 0.78. The financial firm serves as the market maker for 19,000 different issues. The firm can seen as direct play on increased volatility as this increase will lead to more trades. Knight currently handles millions of individual trades each day. Shares of the stock were punished during the recent crisis, but still trade at a cheap P/E of 9.96.

Bottom Line
As the markets continue to gyrate, individual stock picking is becoming more important with each trade. In an attempt to bridge growth and value style investing, GARP may be just what a portfolio needs in these sideways markets. Stocks like Garmin (Nasdaq: GRMN) with its PEG of 1.3 and the proceeding picks are good examples of growth at a reasonable price for a portfolio. (Learn more about GARP, read Stock-Picking Strategies: GARP Investing.)

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