GARP Investing: Golden or Garbage? II

More the latter than the former unfortunately

August 2023. Reading Time: 10 Minutes. Author: Nicolas Rabener.

SUMMARY

  • Buying cheap growth stocks is intuitively appealing to investors
  • Almost 50% of the US stocks are trading below a PEG ratio of 1 currently
  • However, GARP stocks have not generated positive excess returns since 2005

INTRODUCTION

In 2019, we published a research note on growth-at-reasonable-price (GARP) investing (Garp Investing: Golden or Garbage?), where we concluded that the strategy had some nice attributes, eg outperforming significantly during the implosion of the technology bubble in 2001. Fast forward 20 years and another technology bubble burst with some former darlings like Peloton or Zoom having lost more than 90% of their value.

Given this, it would be interesting to see if GARP stocks outperformed again during the correction of growth stocks in 2022. However, there is also a second research question namely that despite the favorable backtesting results, there are surprisingly few mutual funds and ETFs offering exposure to GARP stocks. If this strategy is so good, why aren’t there more products out there?

In this research note, we will have another look at GARP investing.

DEFINING GARP STOCKS

GARP stocks are defined as having a price-earnings-growth (PEG) ratio of below one with the P/E ratio in the nominator and three-year earnings growth in the denominator. We consider all stocks in the US stock market with a market capitalization above $1 billion and create a portfolio by selecting all available GARP stocks. The portfolio is equal-weighted, rebalanced on a monthly basis, and we include 10 basis points for transaction costs.

First, we evaluate the number of GARP stocks in our universe, which varied wildly across time. Specifically, we observe the number of GARP stocks breached 50% during the Global Financial Crisis in 2008, when valuations reached extremely low levels, and has most recently also come close to this magnitude again. In contrast, during bull periods of the stock market like 2010, 2018, or 2021, less than 20% of the stocks featured PEG ratios of below 1.