Garp Investing: Golden or Garbage?

Cheap Growth Stocks – Too Good to Be True?

March 2019. Reading Time: 10 Minutes. Author: Nicolas Rabener.

SUMMARY

  • GARP aims to combine Growth and Value investing
  • GARP stocks have outperformed the market since 1989
  • It is somewhat perplexing how well the strategy worked

VALUE VERSUS GROWTH

With their thousands of employees, suites of products, international reach, and legendary histories, General Electric (GE) and Amazon are true corporate empires. Of course, GE’s fortunes have lately been in decline while Amazon’s are ascendant. But the stocks of these two companies stand for more than just the old versus the new, they also represent a faceoff between two investment styles: Value and Growth.

Most investors are inclined towards Value, a preference backed by ample academic research. But these days picking GE, which trades at a significantly cheaper valuation than Amazon, would be challenging for most investors. The company has structural issues that are reflected in a declining share price and a slew of negative news stories, all of which would give one pause when considering the stock. Amazon has no such dilemmas and is decimating entire industries, secure in its status as the most valuable company on the planet.

Some investors have sought to bridge the Value-Growth divide through a hybrid strategy, opting for the Growth at a Reasonable Price (GARP) approach popularized by Fidelity manager Peter Lynch. But if Value creates positive excess returns as the research demonstrates, then Growth does largely the opposite, which would seem to cast doubt on GARP’s underlying logic. So how do GARP strategies perform in the US stock market? (read Improving the Odds of Value)

METHODOLOGY

Definitions of GARP stocks can vary but are generally based on the price-earnings (P/E) to growth ratio (PEG), which divides the P/E ratio by the growth rate. In our analysis, we derive the PEG from the P/E ratio from the last 12 months of earnings and the three-year growth rate of earnings. Stocks that exhibit a PEG ratio below 1 are classified as GARP stocks. We focus on all US stocks with market capitalizations greater than $1 billion. Indices are rebalanced monthly, each transaction incurs costs of 10 basis points (bps), and stocks are we