One viable approach to investing is seeking growth at a reasonable price (”GARP”) — the P/E ratio divided by the earnings growth rate (”PEG”).  It is a method that attempts to make comparison of P/E ratios between companies more meaningful by considering growth rates.

GARP is a hybrid method that has elements of value investing and elements of growth investing.  The method was popularized by Peter Lynch.

Generally, PEG ratios above 2.0 are considered expensive.  Ratios below 1.0 are considered discounted.  Lynch said that attractive PEG ratios are at or near the earnings growth rate of the company.

The method is imperfect, as are all methods, but it widely used.  It is best applied to companies with above average growth rates, but not growth at extreme levels.

Extreme growth rates create silly or impossible ratios.  Companies growing at sprint burst speed cannot sustain those rates, and show unrealistically low PEG ratios.  Companies with negative growth create negative PEG ratios that are effectively uninterpretable.  Companies with very low growth rates such as 1%, but with strong dividends need to be analyzed with a different method.

Some of the arguments against GARP investing include that fact that it does not have an adjustment factor for ambient interest rates, nor the yield or payout ratio of the company, nor balance sheet issues.

Workarounds for those criticisms are to look for GARP prospects among companies with solid balance sheets, to use PEG ranks rather than absolute PEG thresholds to deal with interest rates issues (although at some level that exposes investors to bubbles), and to compare PEG ratios among companies with similar yield characteristics.

In the GARP filter we present here, we ignored the interest question and the yield question but filtered for GARP prospects among financially strong companies.

Our first step was to select those companies ranked B+ or better by Standard & Poor’s for earnings and dividends growth and stability.  That generated a list of 931 presumably financially strong companies out of the 4,083 that S&P ranks by that dimension.

We then put that list of 931 symbols into a fundamental database and filtered them for PEG ratios based on 5 years of historical earnings growth and five years of estimated future earnings growth.  We used a 1.5 PEG multiple as the upper limit for each of those two PEG measures.  We also required that the 5 year historical and estimated earnings growth rate be positive, and that the trailing 4 quarters of earnings also be positive.  That reduced the list of 931 companies to 65.

You can do the same basic filtering with tools readily available through quality brokers, such as Schwab, or subscription databases you may have.

Note: We expect one or more readers will dig deeply into the filter and discover some inconsistencies between data we used and the data they used.  That happens, because databases are imperfect.  Our list is a beginning point for research, not an ending point.  If a company looks potentially interesting from a filtered list, a prudent investor will go to the source financial statements of the company and fact check before proceeding.  We haven’t done that yet for this filter.  Make sure you do that research before risking capital.

This chart provides an illustration of the kind of data that goes into GARP calculations.  It shows the ten companies with the largest market capitalization that passed the filter.

click image to enlarge

You are best served by doing this sort of filtering yourself with subscription screening tools or ones provided free by your broker.  Because prices change daily, PEG ratios change daily.  PEG ratios change periodically, because earnings history and estimates change periodically.  Don’t rely on a static list.

If you would like to see the full list of 65 stocks that came out in our filter today, along with the following expanded supplemental data points for each company, send us an email and we will send you an Excel spreadsheet with the data.  It’s too much to try to put in an image, and it’s more useful in a spreadsheet that you can manipulate and add additional data if you please.

• Company Name
• Symbol
• Sector
• Industry
• PE
• PE to EPS Growth Trailing 5 Years
• PE to EPS Est Growth 5 Years Forward
• EPS Cont-Growth Trailing 5 Years
• EPS Estimated Growth 5 Years Forward
• EPS Estimated Growth-Current to Next FY
• Price/Sales
• Price/CF
• Price/FCF
• Price/Book
• P/Tangible Book
• Yield ttm
• Payout Ratio ttm
• Current Ratio Q1
• Quick Ratio Q1
• LT Debt/Equity Q1
• LT Debt/Total Capital Q1
• Return on Assets ttm
• Return on Equity ttm
• Times Interest Earned ttm

Securities Mentioned: WMT, IBM, ORCL, ABT, AMGN, CVS, BAX, UNP, FPL, GD.

Disclosure: We own some of the named companies in some accounts.

Richard Shaw
QVM Group LLC

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