Market Buzz

Posted by Ryan Irvine: Keystocks

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Market Buzz – Invest for Value & Growth (GARP)

Value is perhaps the most important concept to understand as an investor (next to risk). Most people intuitively understand this in their everyday lives. Unfortunately, it is less understood in the arena of stock investing. What is value? Value, in this sense, is when you get a great deal on buying an asset. In the case of investing, it is when you are able to buy $1 worth of assets for $0.80 or less. When you are making the purchase of an item, like a house, or a car, or a television, and you put extra effort into finding an item of equal or greater quality, but for a lower price, you have made a value purchase. It is the same in the stock market. When you purchase a share of a company, you are buying an ownership interest in an underlying business – an asset.

Almost any stock will have a story describing how the managers will try to make money, but if it’s a real business, it will have more than just that. It will have real products, real sales, real profits, and real business models. A successful business will generate cash flow and it will reinvest this cash flow for growth or it will pay this cash flow to back to its shareholders in the form of dividends. When we find those unique opportunities to purchase successful businesses at prices well below their real or intrinsic value, we have made a value investment.

The tricky part is determining what the stock is actually worth. This is by no means an exact science (not even close) and there are many different techniques that people use with varying degrees of success.
The reality is that two different people can be given the exact same information on a company and arrive at two different conclusions of what the company is actually worth, and neither one of them is necessarily right or wrong. So rather than trying to determine the exact intrinsic value of the company (stock) you are purchasing, focus more on fundamental principles. If a company is not profitable or is not breaking into profitability, then it is not an investment, it is a speculation.

If the company is trading at a premium price, risk increases. If that company is trading at a discounted price, risk decreases. The more solid companies you buy at attractive prices that are making money, the better your portfolio will perform over time. The more you buy speculative ventures, which are innately impossible to value, the worse your portfolio will do over time.

Having said this, our Small-Cap Research Service is not strictly a “value” service. We are also focused on growth in revenues, cash flow, and earnings per share. As such, our investment style is a hybrid of both value and growth investing. Essentially, we are looking for “Growth at a Reasonable Price,” or GARP as it is affectionately known. GARP is a mix between stocks whose earnings are increasing rapidly and stocks whose price is low relative to underlying assets, like book value, cash, etc. Because GARP is a subjective animal, a precise definition is a difficult exercise.

To simplify things, we will break it down. The “G” or growth is in reference to earnings and/or revenue growth. The “RP” or reasonable price refers to whether a stock is currently considered a value or not based on an analysis of its financial position. As a general rule of thumb, many analysts see GARP when a stock’s price-to-earnings ratio (P/E) is less than half its growth rate. For example, if a potential investment were estimated to grow earnings by 30% next year, GARP analysts generally look for a P/E of 15 or less.

Of course, one’s definition of growth and a reasonable price can differ greatly by sector, market size, and other factors, but this should leave you with a basic understanding of our GARP methodology.

Looniversity – Your Friend GARP

“Growth at a Reasonable Price,” or GARP as it is affectionately known, has gained fame (and hopefully made some fortunes) in recent years, as advisers try to compromise between growth and value – that is, between stocks whose earnings are increasing rapidly and stocks whose price is low relative to underlying assets, like book value, cash, etc. Because GARP is a subjective animal, a precise definition is a difficult exercise.

To simplify things, we will break it down. The “G,” or growth, is in reference to earnings and/or revenue growth. The “RP,” or reasonable price, refers to whether a stock is currently considered a value or not, based on an analysis of its financial position. As a general rule of thumb, many analysts see GARP when a stock’s price-to-earnings ratio (P/E) is less than half its growth rate. For example, if a potential investment was estimated to grow earnings by 30 per cent next year, GARP analysts generally look for a P/E of 15 or less.

Of course, one’s definition of growth and a reasonable price can differ greatly by sector, market size, and, other factors, but this should leave you with a basic understanding of your friend GARP.

Put it to Us?

Q. Would you please give me a quick bit of info on earnings per share, or EPS, and fully diluted EPS?

– Rick Delino; Calgary, Alberta

A. . Earnings, otherwise known as net income or net profit, represent the money that’s left over after a company pays all its bills.

Earnings per share, or EPS, refer to the portion of a company’s profit allocated to each outstanding share of common stock. Calculated as:

= Net Income – Dividends on Preferred Stock
Average Outstanding Shares

Fully diluted earnings per share are a company’s EPS if all convertible securities were exercised. In other words, diluted earnings take into account all warrants, stock options, and convertible bonds if traded in for stock. This would result in an increased number of shares outstanding.

For many investors, the growth of a company’s EPS is the most important factor when analyzing a company. It’s often used as a gauge of profit performance.

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