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The word GARP, in the mind of a professional
investor, does not necessarily refer to the character of the famous
novel of John Irving (The World According To Garp). It is the
nickname of an investment strategy which is related to the growth
approach, and which actual name is Growth At Reasonable Price.
The GARP approach is a happy mix of the
value and growth styles. Its growth side resides in the research
of companies which enjoy profits growth higher than the average of
the companies on the market. Its value side quite simply consists in
paying the lowest possible price for a growth security.
In concrete terms, the disciples of the
GARP approach buy company stocks only on the condition that its
price/earnings ratio is quite lower than its profits growth rate.
The pure and hard "garpists" would even say that true bargains are
recognizable when the price/earnings ratio is two to three times
lower than the expected yearly profits growth rate.
The Microsoft stock, for example, was
negotiated at one point with a price/earnings ratio of approximately
60, whereas the analysts were expecting a profits growth rate of 15%
per year for the next five years. With a price/earnings ratio four
times higher than the growth rate of the profits, the company founded
by Bill Gates is far from being an attractive stock for a "garpist".
The ratio of its price/earnings multiple divided by its profits
growth rate (what the analysts call the PEG ratio for Price Earning
Growth ratio) is 4 (60/15 = 4). It was definitely too high at this
time.
The owner of ski and holiday resorts
Intrawest, traded in New York and Toronto, represented a much better
bargain than Microsoft. At the beginning of March 2002, the stock was
traded in New York with a price/earnings ratio of 14, and ten
analysts who follow the company expected, on average, a growth rate
of the benefit of 19% per year for the next five years. With a PEG
ratio of only 0,74, the Intrawest security portrayed an interesting
candidate for the portfolio of a growth style, cautious and thrifty
investor.
Do you believe that the securities with a PEG
ratio lower than 1 are too rare? 130 securities registered on the
American stock exchanges had a PEG ratio lower than 0,5 on March 12,
2002. In spite of a context where we hear again and again that the
stocks are at prices historically very high, the investor who bothers
to do a little research can always find growth companies which are
traded at a price more than interesting.
The validity of the GARP method.
Despite their great popularity among the
investors during the 90's decade, the growth style investment
strategies were not really the subject of any in-depth studies from
the university financial researchers. The difficulty to agree on a
general definition of what is called a growth security is undoubtedly
related with the lack of interest from the researchers for the
various schools of thought which claim to follow the growth
philosophy.
For all kinds of reasons, the value style
strategies have generated much more interest among the researchers
and continue to fuel their academic works. Like it has been observed
that the securities with low price/book, price/earnings, price/sales
and price/dividends ratios generate, as a rule, returns higher than
the securities having higher ratios, it has been concluded from that
that the value style is definitively better than the growth one.
Then, all the growth type strategies have
been put together, without trying to seek the most elementary
differences and nuances between them. But especially, people remained
blind towards the growth style strategies which could be based on
solid grounds and could generate excellent returns.
One of the rare researchers who have been
interested in the growth strategies is Donald Peters, author of A contrarian strategy for growth stocks
investing. Although the book had been published in 1993 and
that the research data were related to primarily the 80's decade, I'm
confident that the conclusions of the author would apply to the 90's
decade and that they will still be highly relevant for the 2000
decade.
His book could have been the spearhead of a
series of work about the growth type portfolio management, but that
has not been the case. The academic community continues to turn a
deaf ear to the works and the research topics explored by Peters.
Something still brings some comfort all the same: the less a lucrative
investment strategy is known, the longer it lasts and the more intact
its future performance remains.
To be continued in Part 2.
André Gosselin
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