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X-Plained: What is GARP Investing?

24 Sept 2024

Investors often look for quality companies that can keep growing their sales and profits. However, sometimes this can lead investors astray into paying too much for a company which can introduce some stock risk. That’s where an investment strategy like growth at a reasonable price (GARP) comes in. GARP can potentially help investors in capturing growth while safeguarding against the pitfalls of overvaluation, which is when a stock's price is higher than what it's really worth.

Let’s X-Plain:

  • What does GARP investing mean?
  • Why is GARP investing important?
  • How to identify GARP companies?
  • Why use an ASX-listed ETF to invest in GARP stocks?

What Does GARP Investing Mean?

GARP stands for growth at a reasonable price. It’s an investment strategy that aims to strike a balance between growth and value investing.

Growth investing involves investing in companies with strong revenue and earnings growth. While value invests in companies that are trading cheaply to their intrinsic value.

Often these two areas of investing are like a pendulum, switching between the other. GARP is a uniquely positioned strategy that sits at the intersection of both.

GARP’s origin dates back to the 1980s when a famous investor named Peter Lynch popularised the strategy. Lynch managed the Fidelity Magellan Fund, and during his tenure, it was the best-performing fund in the world.1

Why is GARP Investing Important?

Over the short-term, psychology can drive share prices through valuations and market expectations. However, over the long-term, earnings are the main driver of share prices.2

This means investors may want to look for companies that are growing their sales and their earnings. However, if everyone is just buying the high-growth companies, it may compromise on quality and investors could be overpaying from a value perspective.

GARP can provide the best of both worlds - capturing growth potential while maintaining value discipline. This makes it an appealing strategy for long-term investors seeking to gain exposure to global companies.

How to Identify GARP Companies?

Companies that exhibit GARP characteristics have a combination of three different styles:

  • Growth – looking for companies with strong revenue and earnings growth. This refers to companies not only growing their sales over time but also their profits.
  • Value – looking for companies that are trading relatively cheaply compared to their intrinsic value. A common ratio used is the Price to Earning Ratio (called the PE Ratio) which is a simple way to measure what investors are willing to pay for a company’s earnings. A lower PE ratio indicates the company could potentially be undervalued.
  • Quality – looking for companies that have solid financial strength and good fundamentals. This includes companies with low levels of debt (referred to as leverage) and high returns on equity (which effectively shows how the company is using shareholder money to generate profits).

Trying to screen the global stock universe for the above characteristics can be time-consuming, data-intensive, and cumbersome. Not to mention the fact that sometimes high-growth companies change each year, meaning investors may have to constantly rotate their stocks potentially incurring brokerage and tax consequences.

This is where GARP investors could turn to use a low-cost index fund like an exchange traded fund (ETF).

Why use an ASX-listed ETF to Invest in GARP Stocks?

ETFs have democratised access to investing in global companies outside of Australia. An ETF can provide access to hundreds of different companies from all over the world and across different sectors.

An index-based ETF follows a broad set of rules that can incorporate the characteristics of what makes a GARP stock (e.g. growth and value) and incorporate a quality overlay. It can also be delivered to investors at a lower cost than traditional active fund managers3, and trades on the share market like any stock. Read more about how ETFs work here.

A GARP-focused ETF like the Global X S&P World ex Australia GARP ETF (ASX: GARP) provides exposure to ~250 companies that meet the GARP definition. It enables investors to have a disciplined approach to growth investing by finding quality companies that have solid financial strength and trading at reasonable prices, all accessible via a single low-cost product.

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