A pure-play value investor often misses the chance of betting on stocks that have bright long-term prospects. In the same way, growth investors often end up investing in expensive stocks. Going by Warren Buffett, these two approaches are joined at the hip.
Accordingly, some investors sought to join the bridge between value and growth with a hybrid strategy of investment. Their theory suggests that to make a long-term investment more effective the principles of both value and growth strategies need to be combined.
GARP (growth at a reasonable price) investment, often known as a special case of value investment, is gaining popularity. What GARPers look for is whether the stocks are somewhat undervalued and have solid sustainable growth potential (Investopedia).
Several stocks, which have surged significantly in the recent past, show an overwhelming success of this hybrid investing strategy over pure-play value and growth investments. Here we will discuss the success of four such stocks. These include
Academy Sports and Outdoors, Inc. ( ASO Quick Quote ASO - Free Report) , Preferred Apartment Communities ( APTS Quick Quote APTS - Free Report) , Pampa Energia ( PAM Quick Quote PAM - Free Report) , and FedEx Corporation ( FDX Quick Quote FDX - Free Report) . A Few More Words on GARP
One of the fundamental metrics for finding GARP is the price/earnings growth ratio (PEG). Although it is categorized under value investing, this strategy follows the principles of both growth and value investing.
The PEG ratio is defined as (Price/ Earnings)/Earnings Growth Rate
It relates the stocks P/E ratio with the future earnings growth rate.
While P/E alone only gives an idea of stocks that are trading at a discount, PEG, while adding the growth element to it, helps to identify stocks that have solid future potential.
A lower PEG ratio, preferably less than 1, is always better for GARP investors.
Say for example, if a stock's P/E ratio is 10 and the expected long-term growth rate is 15%, the company's PEG will come down to 0.66, a ratio that indicates both undervaluation and future growth potential.
However, the question that often arises is whether the market has an adequate number of companies that are growing earnings while trading at reasonable valuations? Going by a CFA Institute Blog by Nicolas Rabener, “on average, 38% of all stocks exhibit a PEG ratio below 1, which is more than enough for security selection.”
Unfortunately, this ratio is often neglected due to investors' limitations in calculating the future earnings growth rate of a stock.
There are some drawbacks to using the PEG ratio though. It does not consider the very common situation of changing growth rates such as the forecast of the first three years at a very high growth rate followed by a sustainable but lower growth rate in the long term.
Hence, PEG-based investing can turn out to be even more rewarding if some other relevant parameters are also taken into consideration.
Here are the screening criteria for a winning strategy:
PEG Ratio less than X Industry Median P/E Ratio (using F1) less than X Industry Median (For more accurate valuation purposes) Zacks Rank of 1 (Strong Buy) or 2 (Buy) (Whether good market conditions or bad, stocks with a Zacks Rank #1 or #2 have a proven history of success.) Market Capitalization greater than $800 Million (This helps us to focus on companies that have strong liquidity.) Average 20 Day Volume greater than 50,000: A substantial trading volume ensures that the stock is easily tradable. Percentage Change F1 Earnings Estimate Revisions (4 Weeks) greater than 5%: Upward estimate revisions add to the optimism, suggesting further bullishness. Value Score of less than or equal to B: Our research shows that stocks with a Style Score of A or B when combined with a Zacks Rank #1, 2 or 3 (Hold) offer the best upside potential.
Here are the four stocks that qualified the screening:
Academy Sports and Outdoors: Academy Sports is a leading full-line sporting goods and outdoor recreation retailer in the United States. Academy Sports’ product assortment focuses on key categories of outdoor, apparel, footwear and sports & recreation through both leading national brands and a portfolio of 19 private label brands.
Academy Sports is an impressive value investment pick with its Zacks Rank #1 and a Value Score of A. Apart from a discounted PEG and P/E, AutoNation also has an impressive long-term expected growth rate of 15.1%.
Preferred Apartment Communities: Preferred Apartment Communities is a real estate investment trust engaged primarily in the ownership and operation of Class A multifamily properties, with select investments in grocery-anchored shopping centers. Preferred Apartment Communities' investment objective is to generate attractive, stable returns for stockholders by investing in income-producing properties and acquiring or originating real estate loans.
Preferred Apartment Communities can also be an impressive value investment pick with its Zacks Rank #1 and a Value Score of B. Apart from a discounted PEG and P/E, the stock has an impressive long-term expected growth rate of 7%.
Pampa Energia: Pampa Energia is an integrated power company, engaged in the generation and transmission of electricity in Argentina. It operates through Electricity Generation, Oil and Gas, Petrochemicals, and Holding and Other Business segments. Pampa Energia generates electricity through combined thermal generation plants, open-cycle gas turbines, and hydroelectric power generation systems, as well as through a wind farm.
Pampa Energia has an impressive long-term expected growth rate of 49.9%. The stock currently has a Value Score of A and a Zacks Rank #1.
FedEx Corporation: Based in Memphis, TN, FedEx is the leader in global express delivery services. The company provides a broad portfolio of transportation, e-commerce and business services through companies competing collectively, operating independently and managed collaboratively, under the FedEx brand. FedEx is currently reporting, primarily through the FedEx Express (including TNT Express acquired in 2016), FedEx Ground and FedEx Freight segments.
FedEx has an impressive long-term expected growth rate of 12%. The stock currently has a Value Score of A and a Zacks Rank #2.
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