What is Growth At a Reasonable Price (GARP)?
Growth at a reasonable price (GARP) is an investment strategy that combines tenets of both growth and value investing by finding companies that show consistent earnings growth but don't sell at overly high valuations. The term was popularized by legendary investor Peter Lynch.
How Does Growth At a Reasonable Price (GARP) Work?
A fundamental formula for finding GARP is the price/earnings growth ratio (PEG). The ratio divides a company's current P/E ratio by the earnings growth rate and is designed to measure the balance between growth and valuation.PEG optimal PEG ratio is one or less.
For example, let's say Company ABC is trading at $70 per share, and its earnings per share (EPS) forecasted to grow at +20% for the year.
ABC's P/E ratio is ($70/$7 = 10), and its PEG ratio is (10/20 = 0.5).
The PEG is less than one and makes ABC a good candidate for GARP.
Why Does Growth At a Reasonable Price (GARP) Matter?
GARP seeks to avoid the disadvantages or pitfalls possible with pure growth and pure value stocks. Growth stocks can form a bubble by rising very high and crashing very fast while value stocks can go nowhere for a long time. By finding the GARP middle ground, investors seek to enjoy rising prices without being vulnerable to a price crash.
That said, GARP stocks can underperform growth stocks in a growth market and underperform value stocks in a value market. However, GARP can outperform in mixed markets and over the longer term.
[Warren Buffett likes to say that 'growth and value are joined at the hip.' Learn more about substituting the PEG ratio for the P/E ratio by reading The Common Ratio Misleading Generations of Investors.]