Getting to Know Growth, Value, and GARP Stock Investments

Growth stock investments are a staple of many mutual funds and aggressive portfolio strategies. These stocks are generally categorized by having higher-than-average P/E ratios, little or no dividend distributions, and faster-than-average earnings growth expectations. The premise behind this investment strategy is that the company will quickly grow into the high P/E ratio and thus bring the ratio back down over time.

One of the best ways to determine the value of a growth stock is through its price-to-earnings-to-growth (PEG) ratio. A high P/E ratio doesn’t actually mean a stock’s valuation is too expensive if the projected EPS growth rate is similarly boosted. Because fast growth is so vital to this strategy, most tend to be small or mid-cap stocks who can take advantage of economies of scale and gain market share quickly.

Upstart Holdings (UPST) is a classic example of a growth stock. It has a market cap of $6.8 billion and is engaged in developing cloud based A.I. lending platforms for financial institutions. It comes with a relatively high P/E ratio of 34 but shows a projected EPS growth rate of more than 50%.

The biggest risk to growth-oriented investment styles is that the company doesn’t grow as quickly as anticipated. A growth company that doesn’t meet expectations is often subject to a subsequent sell-off in the market as investors prioritize other more lucrative growth options. Volatility in these types of stocks tends to be higher than usual as well since changes in the economic outlook impacts future growth expectations more severely.

Another one of the most common investment strategies used by Wall Street fund managers and Hedge fund gurus is value stock investing. Bargain-buyers and contrarians hunt for undervalued stocks that have been overlooked by Wall Street experts as well making this one of most used strategies by investors regardless of expertise level.

These stocks typically come with low P/E ratios and a higher-than-average dividend yield. While value stocks can be found in any size, the majority of them are large-cap stocks with a decade or more of stock trading history.

Value stocks can be found in out-of-favor market sectors in the business cycle or may simply be companies that no one is paying much attention to. “Unsexy” business such as waste management or manufacturing seldom make headlines and can often trade at prices that don’t quite reflect their true intrinsic values. ABB Ltd (ABB) is a textbook value stock example. The robotics and electronics manufacturer has a sizable market capitalization of $61 billion and offers a hefty 2.95% dividend yield to investors. It carries a low P/E ratio of just 12 while still having a 5-year historical EPS growth rate of 35%. That gives the stock an incredibly low PEG ratio and signals to investors that it is likely trading below its intrinsic value.

Since value stocks are often found in out-of-favor market sectors or have a recent history of a price decline, the primary risk to this strategy is underperformance over time. Even a successfully identified value stock that may have an intrinsic value higher than its current stock price could take years to make a significant move higher.

A term famously coined by Warren Buffet, the growth-at-a-reasonable-price (GARP) strategy is a combination of both growth and value stock strategies. They are most similar to growth stocks, but come with a lower valuation that can sometimes rival what is seen in value stocks.

GARP stocks have higher-than average P/E ratios, but generally aren’t quite as high as those found in growth stocks. One of the biggest differences between the two is the size of the companies – GARP stocks usually come with large market capitalizations.

One of the best examples of a GARP stock is the $222 billion media and entertainment giant, Disney (DIS). It has a P/E ratio of around 36 and a long term EPS growth rate of 41% giving it a PEG ratio of less than 1.

Risks of GARP strategies are largely a mix of both growth and value stock investments. Lower than expected growth along with slow market sector cycling can mean that these stocks can underperform relative to the broader markets.

A well-diversified portfolio should contain a mixture of all of the above stock investment strategies. A portfolio that only holds growth stocks runs a higher risk of volatile up and down price swings than a value-oriented portfolio for example.

By effectively balancing out your stock selections in your investment portfolio, you can achieve the desired mixture to generate the kind of returns you want to have while keeping volatility and risk as low as possible.

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