The historically turbulent September Scaries for stocks (the September to October period) have once again introduced a familiar dose of market volatility for investors.
For value investors, another popular approach to finding success in stocks is through paying for “Growth at a Reasonable Price,” or GARP. It endeavors to achieve a blend both Value and Growth styles of investing—combining the discipline of value investing with the pursuit of growth typically associated with growth investing.
Understanding Growth at a Reasonable Price (GARP)
GARP investing seeks to identify what some might call “Compounding Machines”, that is businesses that can generate high returns on invested capital and reinvest those profits into their operations to fuel future growth. The strategy seeks to avoid the extremes of value traps, where stocks may be cheap but stagnant, as well as overly expensive growth stocks, which may offer compelling stories but carry high risks if the growth fails to materialize. The key lies in finding a balance: paying a fair price for businesses with strong growth prospects.
The Intersection of Value and Growth
For value investors, the general focus is on buying stocks that trade at a discount to their intrinsic value. This tends to include businesses with strong balance sheets, steady cash flow, and a margin of safety. Growth investors, by contrast, tend to prioritize companies with rapid earnings or revenue expansion, even if those companies trade at higher valuations.
What sets GARP investors apart is the desire to marry these two philosophies. Some might even suggest that the growth component of their analysis might act as its own margin of safety, given that a disciplined approach to price is incorporated. The goal is not to chase fast-growing companies at any price, but rather to find those that can grow steadily and generate robust cash flows without being overvalued.
Key Attributes of GARP Stocks
Stocks that might represent “Growth at a Reasonable Price” candidates may have some or all of the following characteristics:
1. Consistent Earnings Growth: A GARP stock should demonstrate reliable, consistent growth in earnings or revenue over the long term. Akre focuses on companies that can sustain their growth through reinvestment and have durable competitive advantages that allow them to maintain profitability.
2. High Return on Invested Capital (ROIC): Companies that generate high returns on invested capital are better equipped to compound shareholder value over time. Akre seeks out businesses that can take the profits they earn and redeploy them into the business at attractive rates of return, creating a compounding effect that accelerates growth.
3. Strong Management Teams: Some management teams play a crucial role in the long-term success of a company. Quality management might not only exhibit competency in their field but also have a long-term vision for growing the business while being excellent capital allocators. A management team that knows how to invest wisely is a key ingredient in creating a compounding machine.
4. Reasonable Valuation: GARP investors avoid overpaying for growth, understanding that even the best companies can become poor investments if bought at excessive valuations. By keeping an eye on metrics like the price-to-earnings (P/E) ratio, price-to-earnings growth (PEG) ratio, and free cash flow yield, one can attempt to avoid overpaying for future growth potential.
Conclusion: GARP and the Power of Compounding
“Growth at a Reasonable Price” is not just a strategy for avoiding the pitfalls of overpriced growth stocks or the stagnant returns of value traps—it’s a powerful approach that can lead to significant wealth creation over time. The ability to hold a single stock for many years—perhaps even decades—can offer potential tax advantages and serves to minimize the need for consistently finding new investments.
This task can difficult given the dynamic world in which we live and ever-present competitive threats in the corporate landscape. Still, by focusing on sustainable growth and purchasing at reasonable valuations, investors can hope to enjoy the benefits of long-term compounding, ultimately achieving wealth through patience, discipline, and a focus on the fundamentals.
Kovitz Investment Group Partners, LLC (“Kovitz”) is an investment adviser registered with the Securities and Exchange Commission. This report should only be considered as a tool in any investment decision and should not be used by itself to make investment decisions. Opinions expressed are only our current opinions or our opinions on the posting date. Any graphs, data, or information in this publication are considered reliably sourced, but no representation is made that it is accurate or complete and should not be relied upon as such. This information is subject to change without notice at any time, based on market and other conditions. Past performance is not indicative of future results, which may vary.
