Invest According To GARP
The Dynamic Wealth Report
August 5, 2010
by Robert Morris, Editor
“The stock market is just one giant casino.”
“I don’t buy stocks… they’re nothing more than lottery tickets.”
“I don’t invest in the market because it’s worse than gambling.”
Have you ever heard comments like this? I have. In fact, the above
quotes are from people I talked to in my stockbroker days.
Each quote is from a different business owner I spoke with in the late
1990s. Back in those days, I was trying to build a client base of
wealthy business owners.
I met with hundreds of them.
However, I was shocked to find many had no clue about investing.
They
were very successful at running businesses. But when it came to
investing… stocks were out of the question.
To them, the stock market was just a “giant casino”.
They didn’t believe you could apply logic and common sense to make money
in the market. Buying a stock was no different than plugging coins into
a slot machine.
Why such a jaded viewpoint?
It’s the oldest story in the book… A lot of these savvy business people
had bought stocks before based on hot tips. Each had been promised a
certain “sure thing” was going to the moon. But in the end, every one of
them ended up losing money.
Here’s the problem…
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Buying stocks based on “hot tips” is not investing. In
fact, the proper term for it is… well, gambling.
My question to these folks is… How can you expect to make money without
a bit of hard work?
Hard work in this case means research.
Now, like skinning cats, there are a hundred different ways to research
stocks. Some people look for low P/E ratios. Others focus on dividends
and strong balance sheets. And still others look for certain kinds of
patterns on a chart.
Personally, I invest according to GARP.
GARP stands for ‘Growth At a Reasonable Price’. It’s a stock picking
strategy made famous by legendary money manager Peter Lynch. As the name
suggests, the strategy combines tenets of both growth and value
investing.
Here’s how it works…
First, I look for strong earnings growth.
Is the company growing earnings consistently faster than the overall
market? If so, is this high earnings growth rate expected to continue
over the next few years? Are analysts raising quarterly and annual
earnings estimates?
Next, I look for a reasonable valuation.
Specifically, I look at the company’s P/E ratio relative to the
projected earnings growth rate. This is a simple valuation metric called
the price/earnings growth ratio or PEG ratio.
A PEG ratio of 1.0 means a company’s P/E is equal to their projected
earnings growth rate. It also means the stock is fairly valued. In other
words, the stock price fully reflects the future earnings growth
potential.
I like companies with PEG ratios between 0.25 and 0.75.
A PEG ratio over 0.75 doesn’t offer much upside potential. And a PEG
ratio below 0.25 usually means something is truly wrong with the
company.
Stocks with PEG ratios between 0.25 and 0.75 typically offer the best
risk/reward. They’re usually solid growth companies with temporarily
undervalued stock prices. Eventually, the market will restore them to
fair value or even a premium valuation.
Let me show you a perfect example…
Back in June 2009, I recommended DRI Corporation (TBUS) in my
Penny
Stock Breakouts advisory service. A wonderful little GARP company
trading for just $1.19 a share.
TBUS is a leading provider of digital communications and surveillance
technology to the transportation market. Their technologies are used on
buses, light rail trains, subway trains, and other transit vehicles.
Here’s what really caught my eye…
The growth outlook for the company was nothing short of stellar. Analysts were forecasting a revenue jump of 22% and earnings growth of
100% for 2009. And the five year projected earnings growth rate was a
hefty 30%.
At the time, TBUS shares were badly mispriced by the market. The stock
was trading at just 12x trailing earnings. And the company’s PEG ratio
was a paltry 0.40.
In other words, TBUS was trading at a 60% discount to their projected
earnings growth rate.
Our timing was perfect. Take a look at the chart below. You’ll see the
shares took off right after my recommendation.
After a short pullback in late June, the shares began a steady upward
climb. They marched higher and higher through July, August, and
September. Finally, in October, after another brief pullback, the shares
soared to a high of $2.84.
That’s
a whopping 139% gain in just over four months!
As you can see, investments according to GARP can really pay off. It’s a
very simple investment strategy. And it often produces astonishing stock
market gains.
Next time you’re looking for a stock, try the GARP approach. Odds are
you’ll get a quality stock and a fatter account balance for your
trouble.
•
Surging Wheat Prices Drive Grains ETF Higher
Wheat prices are surging. A horrible drought has destroyed about 20% of
the Russian wheat crop. And the Russian government just placed a
temporary ban on wheat exports. As a result, the iPath DJ-UBS
Grains ETN (JJG) is up more than 34% since the end of June.
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