Invest According To GARP

| August 5, 2010 | 0 Comments

“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…

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.  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.

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Category: Stocks

About the Author ()

Robert Morris is the editor of Penny Stock All-Stars, an investment advisory focused on discovering small-cap and micro-cap stocks that are destined to become the market’s next Blue Chips. The Wall Street veteran and small-cap stock specialist is also a regular contributor to Penny Stock Research. Every week, Robert shares his thoughts with our readers on a variety of penny stock-related topics. In addition to Penny Stock Research, Robert also writes frequently for two other free financial e-letters, ETF Trading Research and the Dynamic Wealth Report. He’s also the editor of two highly successful and popular investment advisories, Biotech SuperTrader and China Stock Insider.

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