2017 has been a strong year for the stockmarket, but not all investment strategies have done well. Given the bullish conditions, it’s probably no surprise that “value” investing in the market’s cheapest shares has not generally paid off. But good quality stocks with strong price momentum have done much better. And if you were buying growth stocks at reasonable prices at the start of the year, you could have done very well indeed.
Over the past 12 months I’ve used this column to look at various ways of buying “growth” companies. For some investors, fast-paced earnings growth and strong price momentum are highly desirable at any price.Traders like Mark Minervini and William O’Neil are flagbearers for strategies that chase prices higher and exit at the first sign of trouble.
But for other investors, there are limits to how much should be paid for a growth share. This hybrid strategy is known as ‘growth at a reasonable price’ (GARP). It’s often associated with investors ranging from Peter Lynch and James O’Shaughnessy to well known UK fund managers like Mark Slater, Gervais Williams and Dan Nickols.
What does a market-beating GARP strategy look like?
As the name suggests, GARP strategies aim to strike a balance between a company’s growth rate and its valuation. There are different ways of doing this, but a simple GARP strategy tracked by Stockopedia has achieved a theoretical 72.9% gain in 2017. That’s well ahead of any other strategy that we track.
Behind the scenes the approach looks for stocks with PE ratios that are below 20x (a typical ceiling for many value-oriented investors) and those PEs also need to be below the market average.
After that, it’s all about growth and momentum. It looks for double-digit earnings growth over three and five years in companies that are growing profitably, with high returns on capital employed and high margins. The companies also need to have seen positive relative price strength over the past year.
These are by no means the only features that can point to GARP stocks. Some investors like Mark Slater use very specific ratios such as the price/earnings growth rate – or PEG – to understand the balance between growth and value. Others focus on sales growth, cash flow generation and low debt. Whatever metrics you use, the focus is on finding growth but resisting the temptation to overpay for it.
Screening the market for GARP stocks
Over the past year, the high performing GARP strategy we track has rocketed on positions in fast-growing shares like IQE (IQE), Mondi (MNDI), 3i (III) and XLMedia (XLM) and Robert Walters (RWA). Here are some of the companies that are currently passing the rules:
Name Mkt Cap £m 5 Year EPS Growth % PE Ratio ROCE % 1 Year Relative Price Strength Sector Taptica International 235.9 41.9 16.3 39.4 +118.1 Cyclicals Persimmon 8,287 42.9 11.9 28.1 +45.8 Cyclicals Redrow 2,361 48.2 9.16 21.0 +40.5 Cyclicals Berkeley 5,693 36.1 7.64 30.7 +39.3 Cyclicals Barratt Developments 6,495 50.4 10.5 16.2 +30.0 Cyclicals International Consolidated Airlines 13,036 27.6 7.63 15.9 +28.2 Industrials CMC Markets 422.8 69.9 8.05 28.6 +25.1 Financials MJ Gleeson 409.4 227.4 15.5 19.1 +22.8 Financials Telford Homes 311.7 51.4 11.4 17.2 +20.6 Cyclicals Numis 338.4 54.4 12.1 28.5 +19.7 Financials
The standout feature of this list is the high number of housebuilders that pass the GARP rules. This has been a trend since the summer. Stocks like Persimmon (PSN), Berkeley (BKG) and Barratt Developments (BDEV) have all seen impressive price gains in recent years. Yet the construction sector often attracts modest valuations because of its very cyclical nature (in other words, it tends to suffer badly in tough economic times, and everyone knows it).
Others here range from Taptica (TAP), an online marketing business, to International Consolidated Airlines (IAG), financial trading group CMC Markets (CMCX) and the stockbroking firm, Numis (NUM).
Can GARP stocks keep up the pace in 2018?
Part of the appeal of GARP investing is that it targets growth stocks that are less likely to have expensive valuations. Sometimes those cheaper price tags are down to uncertainty or setbacks related to the companies. But in other cases, they may just have been overlooked in favour of more popular and exciting shares (which often carry more risk).
The balance between growth and value has been a winning combination in 2017 but its longer term track record is just as formidable. This strategy hunts down the most promising growth shares with good quality characteristics, but won’t overpay for them. It’s an approach that’s attracted some of the world’s most respected investors. And while all strategies inevitably suffer periods of underperformance, GARP remains a sound strategy based on robust principles.
That’s it from me in 2017. Have a happy Christmas and I’ll look forward to getting back to dissecting some of the best investing strategies in 2018.
Interactive Investor’s Stock Screening series is written by Ben Hobson of Stockopedia.com, the rules-based stockmarket investing website. You can click here to read Richard Beddard’s review of Stockopedia.com and learn more about the site.
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About the Author
Ben Hobson is Investment Strategies Editor at Stockopedia.com. His background is in business analysis and journalism. Ben researches and writes regularly on investment strategy performance and screening ideas for Stockopedia.com. He is the author of several ebooks including “How to Make Money in Value Stocks” and “The Smart Money Playbook”
This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.