GARP Revisited

Markets are now offering growth at a reasonable price.

Some readers may recall that at the end of March I wrote a guide to the growth-at-a-reasonable-price (GARP) investment strategy. I ended by asking if there were any good GARP stocks left and said I would have a look in a follow-up article.

Promises, promises

I'm afraid I had to confess to my editor in April that I wasn't finding a lot of GARP candidates, and would have to put off the article until a later date.

The trouble was that forecast price/earnings-to-growth (PEG) ratios -- the key to GARP investing -- were generally looking rather rich. A PEG of 1, you may recall, indicates fair value, whilst anything less than 1 is in growth-at-a-reasonable-price territory. So, I was seeing a lot of companies with PEG ratios above 1 in the spring.

What was going on? Well, the market was just approaching what has since proved to be the peak of a year-long bull run, pricing in higher earnings growth than analysts were forecasting -- analysts who, let's not forget, tend to be conservative in making upwards earnings revisions coming out of a recession.

In other words, for PEG ratios to look more attractive it required a fall in the market or a rise in earnings forecasts, or both.

Screening for GARP

Having watched the market wend its way down from its April high and seen some forecast earnings upgrades, I thought it was time to take another look for possible GARP candidates.

Last weekend I ran a screen of the FTSE 350 for companies with earnings growth of 10%-35% last year, forecast earnings growth of the same order, and a forecast PEG of 1 or less.

Here are the companies which jumped through the hoops:

I used Digital Look for this screen. Different data providers often use different historic EPS figures and different methodologies for consensus forecasts, so their screens will inevitably generate slightly different lists.

It's also worth noting that, although I confined myself to the FTSE 350 for a manageable shortlist, the universe of smaller companies can be fertile territory.

Parameters

In the original article I suggested that GARPers were interested in annual earnings growth in the region of 15%-25%. I used 10%-35% in the screen to make some allowance for the earnings volatility we've seen of late.

I also noted in the original article that GARPers avoid extreme price/earnings (P/E) ratios, being wary of going much below 10 or above 20. The companies above are in the range 10-22, so pretty reasonable on that score.

These companies, then, have the key fundamentals of GARP stocks. But you may recall that GARPers also use a variety of other financial metrics, as well as seeking a qualitative understanding of companies and their businesses.

There's no magic mechanical formula for distilling 'pure' GARP stocks from a screened shortlist such as the one above: experience, interpretation and subjectivity all come into play.

Earnings consistency

One big issue for many possible GARP candidates today arises from the ferocity of the recent UK recession, which has played havoc with the multi-year trends of consistent earnings growth that GARPers prize so highly.

I think one needs to be somewhat pragmatic about the major earnings hiccups many companies suffered in 2008/09, but it would be interesting to hear how committed GARP investors are handling this (comments in the box at the bottom of the page, please).

GARP in emerging markets

Jim Slater once remarked that "elephants don't gallop," but three megacap companies appear in my table -- and they've been going at quite a clip for quite a few years now!

The two tobacco companies -- British American and Imperial -- and drinks company SABMiller are on PEGs of 1 (fair value), together with condom-maker SSL International, which Lee Samaha praised in a recent article. A little share price weakness and/or earnings upgrades would bring them into GARP territory.

Significantly, fags, booze and contraceptives tend to be in demand whatever the economic conditions. Moreover, emerging markets have been the drivers of the earnings growth of these companies -- in fact, significant emerging markets exposure is a feature of the majority of the companies in the table.

Intuitively, emerging markets, with their higher GDP growth projections, will probably be the most productive place for employing a GARP strategy.

Anthony Bolton certainly thinks so, having said that he will be using "more of a GARP-like approach than pure value" for his much-discussed China Special Situations investment trust.

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