Tag: PEG ratio

  • What is GARP And GARP Investing?

    What is GARP And GARP Investing?

    What is GARP And GARP Investing?
    The definition of GARP stock can vary but is based on the P/E to PEG ratio, which divides the P/E ratio by the growth rate.

    What is  GARP or longer, Growth At a Reasonable Price? Growth at a reasonable price or short GARP is an investment strategy. This strategy unites the principles of both growth and value investing. How does it do that?  When you find the companies that have consistent earnings growth but don’t sell at too high valuations. This term was introduced by investor Peter Lynch.  

    While combining principles of growth investing and value investing it serves traders to pick individual stocks. GARP investors look for companies with steady earnings growth that is higher than market levels. That means they are eliminating companies that have very high valuations. The general goal is to avoid the extremes in any type, growth, and value investing.

    GARP investors invest in growth stocks but such that have multiples low price/earnings (P/E) in average market conditions.

    What is GARP Investing?

    GARP investing or growth at a reasonable price is a combination of value and growth investing, as we said. GARP investors seek companies that are slightly undervalued but with sustainable growth potential. Their criteria are almost the mixture of those that the value and growth investors use. Stable earnings growth is still on top position as one of the most important features but also valuation has a great influence on whether they pick a particular stock or not.

    Building such a portfolio that consists of “Growth At a Reasonable Price stock” isn’t just picking the stocks with an equivalent amount of growth and value. The point is to choose the stock that each has qualities of both, value and growth.

    Aggressive growth investors never pay too much attention to the value of the stock. Here are some reasons why they should consider the value of the stock. Let’s say that growth investors profiting from stocks with excellent earnings growth. Such companies are beating all earnings estimates all the time. Do they have any guarantee that the companies will resume performing with success and how long? They could make a profit only if the company proceeds to generate high profit and grow constantly. But what will happen if it stops to do so? 

    Here we have the value in the scene. Value is important to understand the level of investors’ expectations related to the particular stock. Also, value is helpful to gauge how far some growth stock could drop if it starts to sink. To put this simple, value adds a portion of reasonable thoughts and exact estimates into the calculation. 

    How does GARP work?

    A basic formula for finding GARP is the PEG ratio. It is aimed to measure the balance between growth and value. The optimal PEG ratio should be one or under the one.

    Here is how it works. Let’s say the company is trading at $50 per share with EPS forecasted to rise for15% over the year. 

    P/E ratio = $50/$5 = $10
    PEG ratio = 10/15 = 0,66

    This PEG which is less than 1, makes this company a good candidate for GARP.

    Why does Growth At a Reasonable Price matter?

    This could be an added explanation of what is GARP. GARP helps investors to avoid the possible problems or traps that they may have with complete investing in growth or value stocks. If growth stocks rise too high they may create a bubble that could burst in a minute. On the other hand, value stocks can stay the same in the price for a long time. With GARP investors could find the golden middle zone. The investment stability where they can benefit from rising prices of growth stocks but, at the same time, they’ll be protected with value stocks if the growth starts to fall.

    Some may say that GARP stocks will underperform growth stocks in a growth market. Also, such will notice that GARP stocks will underperform value stocks too but in the value market. Despite these criticisms and objections, GARP could easily outperform in combined markets and could do it over a long time.

    What is a GARP strategy?

    It is a mixed approach to growth and value stock-picking. This kind of investor obtains a combination of returns. In other words, the GARP investing strategy is hybrid.
    In GARP investing it is necessary to look for low price/book ratios and a PEG ratio of less than one, as we said.

    P/B ratio = current price/book value per share
    PEG ratio = P/E ratio/predicted growth in earnings

    We said a GARP investor will obtain a combination of returns. This actually means, when markets are dropping it is better for value investors. Hence, markets are rising. It is better for growth investors. On the other hand, GARP investors could benefit from any market condition because they are somewhere between the mentioned types of investors but unite characteristics of both.

    What is it in essence?

    Growth At a Reasonable Price investing doesn’t have inflexible limits for adding or eliminating stocks. The basic benchmark is the PEG ratio. The PEG presents the ratio between a company’s valuation (P/E ratio) and its required earnings growth rate for the next several years, for example. If stocks have a PEG of 1 or less,  that means the P/E ratio is in line with predicted earnings growth. This helps to find a stock that is trading at a reasonable price.

    During a bear market or other declines in stocks, the returns of GARP investors could be higher than the growth investors can get. However, in comparison to the value investors, GARP investors may have average or under average returns. But since GARP investors hold stocks with characteristics of both growth and value stocks, the average returns they get is higher than average returns for growth and value investors can get from their investments separated.

    Bottom line

    GARP stocks are picked by a joining of earnings growth and valuation when investors want to evaluate the right picks. The idea behind this is to recognize cheap stocks with a growing possibility in the future. Hence, the earnings growth of GARP stocks is notable above that of the market.

    GARP is the abbreviation for “growth at a reasonable price” and represents truly a combination of value and growth investing. So, GARP investors seek for a stock that is trading for somewhat less than its predicted value but has earnings growth potential. GARP stocks are slightly lowered but can grow soon. So, what is GARP? It’s all about how to find stocks that have a future.

  • Value Investing Tools That Every Investor Must Use

    Value Investing Tools That Every Investor Must Use

    Value Investing Tools That Every Investor Must Use
    “An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.” – Benjamin Graham

    To find accurate value investing tools you’ll need time, a lot of it to do your homework. Finding the right tools requires a lot of research. It is the same as finding a good value stock to invest in. It can be so complicated that many investors are scared of all that job. 

    But if you don’t like to do your own research, here are some tricks to help you. 

    By having the value investing tools to value a company and evaluate its prospects, you can eliminate unsuitable stocks. Also, you can do it more quickly and focus on the best picks. One of the most accurate among value investing tools is the P/E ratio. 

    P/E ratios as value investing tools 

    The price-earnings ratio or P/E ratio is classified as a primary tool to identify undervalued or cheap stock. It is a simple metric that is easy to calculate. All you have to do is to divide a stock’s price per share by its earnings per share. Earnings per share is shortly expressed as EPS. Value investors always have the P/E ratio in their value investing tools boxes and seek a low P/E ratio. A lower ratio means that they will pay less per each dollar of the company’s current earnings.

    But this metric has some downsides. Of course, it is still a good start but if you rely on this one measure solely it is more likely your strategy will not be accurate and successful. 

    Investors are frequently attracted by low P/E ratio stocks. The problem is that they can be inaccurate and inflated numbers. Sometimes, companies report incorrectly high earnings sums or some forecasts show much higher earnings, so the low P/E ratio can be false. Everything becomes more clear after real earnings reports and the P/E ratio goes up and investors’ research result is false too.

    So, if you use the P/E ratio alone you’ll end up trapped with the wrong decision.

    Use PEG ratios as value investing tools

    If the P/E ratio is flawed, what should you do to find true value stocks? Which one of the value investing tools you have to use? PEG ratio will help you to recognize if a company with earnings growth is trading below its intrinsic value. The price-to-earnings ratio or PEG ratio can help you to avoid some traps while searching for value stocks. To calculate the PEG ratio use this formula:

    PEG Ratio = Price To Earnings Ratio / Earnings Growth Rate

    If the PEG ratio is less than 1 it is supposed to be a sign of an undervalued stock and it is possible to buy such stock at discount. So, the PEG ratio of 1 means the company is correctly valued. Contrary, if the PEG ratio is above 1 it may indicate that a stock is too expensive. But the PEG ratio shouldn’t be used as an individual metric. The valuation puzzle requires using other value investing tools to have a comprehensive picture of the stock’s value. 

    For many investors, the PEG ratio is a favorite among value investing tools due to its ability to show the stock that is at discount. However, as with all of the value investing tools the PEG ratio is useful to recognize the stock that could deserve a closer look. You’ll need more research and tools to reveal the possibility that the stock is cheap for a reason, in which case it isn’t the right choice. Simply, you wouldn’t want such stock in your investment portfolios.

    But keep in mind, for example, various industries will have different PEG ratios. So be careful when judging the company’s value.

    The company’s cash flow

    The company is worth only the amount of the future cash flows it can make from its operations. Keep this in mind. The value investors will always check the company’s cash flow before starting to invest. 

    As we noticed above, the P/E ratio is by no means a complete measure. The company’s net income is only an accounting entry and it is often influenced by numerous non-cash costs, for example, by depreciation. Also, companies use tricks to misrepresent their earnings. As a difference, cash flows measure the real money that the companies paid out or acquired over a given period. 

    Cash flows exclude the influence of non-cash accounting charges. They don’t include depreciation or amortization. So they are more objective value investing tools because they only admit the real cash that flows into or out of a company. Cash flows are a clear picture of the company’s real profitability. However, we have to repeat, it makes no sense to estimate cash flows as the only tool you use when seeking the value investment. 

    Enterprise value

    It is important to compare operating cash flow to the company’s Enterprise Value if you want a clearer picture of the amount of cash the business is generating related to its total value.

    To explain the enterprise value. 

    It is as a number that in theory outlines the full cost of a company if someone buys 100% of it. If the company is publicly-traded, this means buying up every single of the company’s shares.

    To calculate it you have to sum up the company’s market capitalization, add debt, preferred stock together, and subtract out the company’s cash balance. The result will show how much money an investor or group of them would need to buy the whole company. So, it is an outstanding picture of the total value of the company.
    When you divide a company’s operating cash flow by its enterprise value, you can easily calculate the company’s operating cash flow yield. 

    These measures are also the value investing tools. Especially cash flow yield because it presents the amount of cash that the company generates per year in comparison to the total value investors invested in the company.

    Return-on-Equity – ROE is excellent for value investing tool

    ROE is another excellent tool that can help you to find value stocks.  

    It is a profitability ratio and measures the ability of a company to generate profits from its shareholders’ investments. To put it simpler, the ROE shows how much profit generates each dollar of stockholders’ investment generates.
    The ROE of 1 indicates that every dollar of stockholders’ investments generates 1 dollar of net income. This measure shows how efficiently a company uses investors’ equity to generate net income.

    ROE is also an indicator of how efficient management is.

    The formula is 

    ROE = Net Income / Shareholders’ equity

    This measure is broadly used, and it is easy to find the ROE lists for publicly traded companies on almost all financial websites. When investors look for value investment opportunities, they are looking to find a stable or growing ROE of the company. 

    However, there are some cautions. For example, some companies can produce enormous ROE in one year, but the next one or more years later resulted in reduced profitability.

    Also, the tricky part is the relationship between ROE and debt. For example, if the company is taking higher debt loads it is possible to use debt capital instead of equity capital. Such a company will have a higher ROE. These companies with exponential and fast growth can be favorable, but also, can ruin shareholder value. Investors prefer ROE at around the average of the S&P 500. 

    Bottom line

    Sadly, there’s no fixed method that will provide investors a distinct way to reveal the best value stock for investing. Investors have to take into consideration the company’s sector and industry, also, if the company has an advantage over its peers. Look for the companies that are able to become brands, or have some unique product, the new technology, in other words, with a sustainable competitive advantage. 

    Remember, some companies operate in a cyclical market. For example, automakers. Such companies will have great growth and huge returns in periods of the rising economy but they will fail if the economy is in a slowdown. So think about the company’s profitability under all conditions. 

    These value investing tools will help you to uncover plenty of potential picks and to find a good stock to invest with trust.

  • Is PEG Ratio Really Useful?

    Is PEG Ratio Really Useful?

    Is PEG Ratio Really Useful?

    The PEG ratio is one of the most popular metrics. It is so easy to calculate it. It never takes more than 10 secs even if you are not good at math. 

    But, what do you think, is this extremely simple metric, this PEG ratio really useful?

    Let’s see. Let’s examine it a bit more on some examples.

    First of all, the PEG ratio or the price/earnings to growth ratio is a stock valuation measure. Investors use it to evaluate a company’s performance and investment risk. It is a measure, so it can be calculated. 

    When the PEG ratio value is 1 we can say there is an excellent bond between the company’s market value and its expected earnings growth. If the PEG ratio is higher than 1, the stock is overvalued. But when the PEG ratio is lower than 1, the stock is undervalued.

    The formula for PEG ratio is:

    PE Ratio (Price/Earnings) / Expected Growth Rate = PEG Ratio

    Assume we are examining two stocks with different characteristics

    Stock A company: 

    price – $20/share
    earnings – $4/share
    expected EPS growth – 5%

    Stock B company: 

    price – $40/share
    earnings – $4/share
    expected EPS growth = 20%

    For stock A company

    P/E ratio = $20/$4 = 5
    PEG ratio = 5/5 = 1

    For stock B company

    P/E ratio = $40/$4 = 10
    PEG ratio = 10/20 = 0.5

    If we study the P/E ratio for valuation plans, we will discover that the stock B company has an advantage because it has a P/E ratio that is 50% less than that stock A company has. But if you find that company A is going to improve its earnings 5 times faster than company B, you may modify your opinion. If you use the price to earnings growth, you will see that the stock A company trades at a lower PEG ratio than stock B company. So, what can we conclude? Company A stock may give a better value.

     

    But is that really true?

    Well, there are some weaknesses connected to the PEG ratio. Earnings growth is not an isolated thing in the market minds. To get a whole picture of the stock value you have to take care of many factors such as cash flow, dividends, revenue growth, etc.

    Further, when it comes to “growth” in the phrase “price/earnings to growth ratio” you will be faced with one problem when you are trying to value a company. You actually don’t know the rate of earnings growth. In the best case, you can guess or rely on Wall Street analysts. Having thin in mind, your PEG will be as good as your data is.

    Well, something is good with the PEG ratio. It is very useful for smaller companies but for large companies (for example Disney or Ford) where the growth isn’t so important to total returns, it can cheat.

     

    So, is the PEG ratio really useful?

    You have to keep in mind that it isn’t a mathematical result. The method is as good as its inputs. The future growth rate could be the main problem in this PEG formula. When you or any analyst make forecasts about the future it can be wrong.

    To make it clear, it is easy to calculate the PEG ratio for companies with weak growth. But, mature companies with excellent earnings and great dividends, have a slow growth rate. So, such companies will never have a PEG ratio of 1 or less. Right?

    It is almost the same for companies with fast growth.

    For instance, a company growing in a surplus of 30% per year will be incapable to maintain such a growth rate. Can you see how the PEG ratio is as good as its inputs? A huge amount of failures in the future earnings growth rises from a too optimistic or too pessimistic viewpoint for the company or industry. Getting an exact PEG ratio depends on what factors you use in the calculation. You may find that the PEG ratio is incorrect if you use historical growth rates. This one especially can lead to mistakes when future growth varies from the past.

    Bottom line

    Traders-Paradise wants to give some spotlight on the pros and cons of using the PEG ratio. As the answer to a question Is PEG ratio really useful, we can say: the PEG ratio is useful but only when you use it to improve a more precise discounted cash flow analysis or relative valuation.