The Case for GARP Stocks: Summary & Key Points
- As documented extensively in our research, many “growth stocks” have soared due to a misplaced focus on the growth rate of revenues without any focus on earnings creating an opportunity in growth at a reasonable price
- The myopic focus on sales growth left an entire asset class of stocks with high earnings growth at reasonable valuations behind, and these stocks look uncommonly appealing today, in our view
- After two years of struggling, recent results from our GARP stock screener and its associated model portfolio have been stunning, and we believe growth at a reasonable price may continue to offer terrific risk and return trade-offs, particularly when compared to rank speculative investments
- Recent outsized GARP results should persist when compared to core indexes, in our view
- Our GARP investment strategy reconciles the debate around the merits of growth and value investing by offering investors the best of both worlds in one concentrated portfolio of stocks that offer growth at a reasonable price
The chart below shows the rolling 12-month excess returns of our GARP Model vs. its benchmark. As one of the first products built by the team, it has been in live production since 2011. We explained the methodology that underpins the model in our piece The Siren Song of Growth – Why Investors Willfully Set Sail for the Rocks.
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In that piece, we explained how to improve security selection among stocks with earnings growth rates well above the market. The model portfolios built by the associated ranking tool are highly concentrated in a small number of stocks offering growth at a reasonable price.
Since its inception, the product has put up significant excess returns. For almost seven straight years, the model offered GARP investors a reliable source of alpha. That came to a screeching halt when the growth bubble took off in 2017. From April of 2017 – February of 2020, the model, like all GARP investors, took a ruthless beating as people crowded into high-priced, low-quality companies that often featured abysmal fundamentals
You can see that recent results have been stunning. The rest of this paper explains why we believe this is only the beginning of what will be a long run for fundamentally sound growth stocks at the expense of stocks with fast growth in sales but lacking profits. We believe the recent rally is a new dawn for discplined GARP investors.