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This continues the first part of the paper The Growth Style According To GARP.
Peters was focused on the universe of the
growth companies which profits are forecasted by at least two
analysts. Their profits growth is higher than 12% per year, and they
have delivered positive profits during their four more recent
quarters.
As the following table shows, the total
return of the American stocks which belong to the decile having the
lower PEG ratio was, between 82 and 89, four times higher than the
return of the S&P 500 index. The performance of the securities
making the first rank decile is rather impressive, especially when it
is known that the 80's were not very favorable for the growth type
investment strategies. On the opposite, the securities making the
deciles number 5 to 10 (high PEG ratio) did not succeed in doing
better than the return of the S&P 500. The yields are calculated on
the basis of 1$ invested in each decile (and reinvested with the
interests in each new quarterly selection), for the whole period which
goes from January 82 to June 89. The first column classifies the
securities according to their PEG ratio value, from the lowest (decile
1) to the highest (decile 10).
Decile Rank |
Performance |
| 1st |
15.36$ |
| 2nd |
6.69$ |
| 3rd |
4.77$ |
| 4th |
3.66$ |
| 5th |
3.00$ |
| 6th |
2.02$ |
| 7th |
1.82$ |
| 8th |
1.55$ |
| 9th |
1.31$ |
| 10th |
1.38$ |
| Average return |
3.04$ |
| S&P 500 return |
3.56$ |
The data of Peters' work illustrate a rather strong and regular
tendency: the lower the PEG ratio of the portfolio, the higher the stock market investment
return. To Seek the highest possible growth at any price is a suicidal act. It is much better
to choose companies with a moderated growth, and check that their price/earnings ratio is
smaller than their profits growth rate.
By doing so, nasty surprises can be avoided. Indeed, the major
problem with the securities which have a high PEG ratio is that their profits growth rates
expected by the experts are way too high. When the analysts expect, for a given company, a
growth rate of more than 50% per year for the next five years, they are too often over
optimistic.
Analysts and the company size
The PEG ratio includes an objective part and a subjective part. The
price/earnings part (or PE) is obviously the objective portion, whereas the expected profits
growth rate (or G for growth) is more subjective since it implies the judgment of a group of
financial analysts. Then, is the number of analysts who make forecasts on the company profits
a significant variable to consider in a strategy of growth at good price? It seems very well
that yes, it is.
In around ten academic articles published in the 80's, professors
Avner Arbel and Paul Strebel have demonstrated that the companies which were the less exposed
to the analysts' investigations generated the best returns. No matter what its size
or its risk level is, the less a company is monitored by the analysts, the better its stock
market return.
The data gathered by Peters shows that in the universe of the growth
companies, the number of analysts who monitor a company has much less importance, in terms of
yields, than the PEG ratio. However, within the group of the 20% of the securities which have
the lower PEG ratio, the best returns come from the companies followed by a number of
analysts between 7 and 15. Furthermore, the companies with a low PEG ratio monitored by less
than 5 analysts generate better returns than those which are monitored by more than 20
analysts.
In general, the more a company is the subject of research reports
from the analysts (with buy or sale recommendations, quarterly and annual profits forecasts,
etc), the larger the company. However, the studies of Peters show clearly that the low PEG
ratio securities yields are higher within the of small or medium size companies. But do not
forget a thing: no matter what the size of the companies are, it is always the securities
that have a rather low PEG ratio which perform the best.
Overall, a good "garpist" strategy must take more into
account the company size than the number of analysts monitoring them. As soon as the choice
is restricted to the companies with a PEG ratio lower than 0.60, the best returns are
obtained within this 20% of the companies which have the smallest stock exchange
capitalization.
Profits surprise and earnings revisions
The growth companies which are expected to enjoy an increase of their
profits higher than the average are, more than often, prone to downgrades of their profits
forecasts from the analysts. It is nothing but astonishing, because the analysts have the
tendency to be too optimistic with their forecasts.
When profits forecasts prove to be too optimistic, and that the
analysts revise their expectation downwards, the stock exchange prices of the concerned
companies sustain a correction rally. On the contrary, when the generated profits are higher
than the expectations, and on top of that the analysts upgrade their future forecasts to take
into account this new deal, the stock exchange price gains can be substantial and exceed the
standard over a period than can reach one year. The top of the top is reached when the
profits reported by a company exceed successively their initial analysts' forecasts and their
revised ones.
This way, the most success "garpists" will make sure than
the securities which meet their requirements in terms of PEG ratio are also companies which
have generated profits exceeding the analysts' forecasts during the last four quarters. Their
tactic is totally consistent, since the upgraded forecasts confirm that the initial forecasts
were realistic, cautious and even conservative.
André Gosselin
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