GARP Investing, Low-Priced Growth Equities

  • Before the recent market skid, investors were buying energy and low-priced stocks.
  • Steven DeSanctis at Jefferies says they’ve been ignoring sensibly-priced growth stocks.
  • He says those “GARP” companies are due to recover, as they rarely struggle for very long.

At various times over the first half of 2022, investors have been attracted to different investment strategies as they try to escape the jaws of a


bear market

.

Earlier this year the low valuations of cheap stocks made them particularly appealing, while focusing on economically sensitive companies like energy firms seemed to be a winning bet. Jefferies strategist Steven DeSanctis recently noted that momentum investing – buying stocks that are already on the way up – has worked out well, too.

One approach that hasn’t worked at all is a sensible standby called “growth at a reasonable price,” or GARP.

“GARP investing has been out of favor over the last year and having one of its longest underperformance cycles ever,” DeSanctis wrote in a recent note, adding that GARP is also lagging other investment factors by an unusually big margin. “We look for this factor to rebound, as performance has reached an extreme, and the factor tends to work when the economy slows.”

DeSanctis wrote that he looks for appealing GARP stocks by comparing each company’s annual price-to-earnings growth ratio to its projected long-term growth rate. But because it’s a tumultuous period, DeSanctis looked at the second-cheapest 25% of small-cap stocks, not the least expensive.

“It has had solid performance over time with its annual return coming in at 13.4%,” he wrote of the quartile. “However, YTD this group is down 24.4%.”

In part, he thinks the stocks will make a comeback soon because it’s very unusual for them to do this badly for this long.

“We looked across our Buy-rated coverage for names that ranked in Q2 based on P / E to growth, but also had to look attractive on FCF yield,” he said. “We think the factor is due to snap back.”

FCF yield, or free cash flow yield, is another measurement of corporate financial health that investors pay close attention to. It shows how much cash the company is able to generate after expenses and compares that number to the company’s market value to show what kind of returns it offers to investors.

The stocks below are ranked from highest to lowest based on that ratio of price to earnings to long-term projected growth. The lower the number is, the more “reasonable” the price of that company’s long-term growth looks.

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