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 five such stocks. These include
United Rentals ( URI Quick Quote URI - Free Report) , Marathon Petroleum ( MPC Quick Quote MPC - Free Report) , Chubb Limited ( CB Quick Quote CB - Free Report) , Annaly Capital Management ( NLY Quick Quote NLY - Free Report) and Archer Daniels Midland ( ADM Quick Quote ADM - 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 five out of the 28 stocks that qualified the screening:
United Rentals: Headquartered in Stamford, CT, United Rentals is the largest equipment rental company in the world, with an integrated network of 1,390 rental locations in the United States, Canada and Europe. Moreover, it operates in 49 states and every Canadian province. URI offers 4,400 classes of equipment for rent at a total original equipment cost (“OEC”) of $16.6 billion (as of June 2022).
United Rentals is an impressive value investment pick with its Zacks Rank #2 and a Value Score of A. Apart from a discounted PEG and P/E, United Rentals also has an impressive long-term expected growth rate of 17.6%.
Marathon Petroleum: Findlay, OH-based Marathon Petroleum is a leading independent refiner, transporter and marketer of petroleum products. Marathon Petroleum operates in two segments: Refining and Marketing and Pipeline Transportation. The Refining and Marketing unit’s operations include 16 refineries, located in the West Coast, Gulf Coast and the Mid-Continent regions of the United States, having a combined crude processing capacity of more than 3 million barrels per day. The Midstream unit mainly reflects Marathon Petroleum’s general partner and majority limited partner interests in MPLX LP and Andeavor Logistics LP.
Marathon Petroleum can also be an impressive value investment pick with its Zacks Rank #2 and a Value Score of A. Apart from a discounted PEG and P/E, the stock has an impressive long-term expected growth rate of 23%.
Chubb Limited: Headquartered in Zurich, Switzerland, Chubb Limited, formerly known as ACE Limited, boasts being one of the world’s largest providers of property and casualty (P&C) insurance and reinsurance and the largest publicly traded P&C insurer, based on a market capitalization of $56.9 billion. Chubb has diversified through acquisitions into many specialty lines, including marine, medical risk, excess property, environmental and terrorism insurance and has local operations in 54 countries and territories.
Chubb has an impressive long-term expected growth rate of 10%. The stock currently has a Value Score of A and a Zacks Rank #2.
Annaly Capital: Annaly Capital is a mortgage real estate investment trust (mREIT) that primarily owns, manages and finances a portfolio of real-estate-related investment securities. Its investment portfolio includes mortgage pass-through certificates, collateralized mortgage obligations (CMOs), credit risk transfer (CRT). The company’s investment may also comprise other securities indicating interests in or obligations backed by pools of mortgage loans, residential mortgage loans, MSR and corporate debt.
Annaly Capital has an impressive long-term expected growth rate of 5%. The stock currently has a Value Score of A and a Zacks Rank #2.
Archer Daniels Midland: Incorporated in Delaware in 1923, Archer Daniels Midland Company is the successor to the Daniels Linseed Co. The company processes oilseeds, corn, wheat, cocoa and other feedstuffs. Moreover, it engages in the manufacturing, sale and distribution of products like natural flavor ingredients, flavor systems, natural colors, proteins, emulsifiers, soluble fiber, polyols, hydrocolloids, natural health and nutrition products as well as other specialty food and feed ingredients.
Archer Daniels Midland has an impressive long-term historical growth rate of 16.5%. The stock currently has a Value Score of A and a Zacks Rank #2.
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Click here to sign up for a free trial to the Research Wizard today. Disclosure: Officers, directors and/or employees of Zacks Investment Research may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material. An affiliated investment advisory firm may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material. Disclosure: Performance information for Zacks’ portfolios and strategies are available at: https://www.zacks.com/performance .
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