Growth-at-a-reasonable-price, or "GARP", investing is a way to combine the tenants of both value investing with growth investing to find stocks with the potential for both earnings increases and valuation increases. When it works, investors enjoy the double play of stock price growth based on earnings (or sales), and a market multiple increase on those earnings, which can lead to really fantastic returns. One of the most famous investors of all time, Peter Lynch, used GARP as his primary strategy, and many other successful investors like Shelby Davis also were and are very successful with it. We use the GARP philosophy when choosing stocks for our Top Buys list.
The strategy I follow, MagicFormula® Investing (MFI), is a value-based screen, so by design we should have the "reasonable price" part covered. But what about growth? Are there some GARP candidates hiding in the screen today?
When looking for growth, we have to be careful. Earnings growth can come in many forms, some of it sustainable and some not. We don't want to fall into the trap of thinking that one-time revenue windfalls, big acquisitions or mergers, massive share buybacks, or favorable and non-recurring tax refunds constitute growth. To keep it simple, I've combed the screen for stocks with recent (most recent quarter) and sustainable year-over-year revenue growth exceeding 15%. These stocks could represent interesting GARP candidates. I've included some brief thoughts on each, but investors should of course do their own research before buying.
Francesca's is a 450-store retailer of women's apparel and accessories. The chain looks to have a nice growth ramp, with a target store count of 900 and new openings of 75-80 stores a year (15-20% store growth). At a P/E of just 15 and a MFI earnings yield of nearly 12%, we've got the value side covered as well. The market is concerned about recently contracting same-store sales - for Q3, Francesca's expects same-store sales to decline 2-5%.
No sector in MFI has been more collectively more successful than multi-level marketing (MLM). Any MLM firm showing up in the screens immediately gets my attention, as Herbalife (HLF), Nu Skin (NUS), and USANA have all posted robust share price gains this year. USANA has had great success in China, growing revenues 37% in the last quarter. There should be plenty of growth left in the land of Mao, and USNA's 10% MFI earnings yield (16 P/E) is hardly a rich price to pay for it.
The U.S. experienced yet another gun boom in 2013, and Smith & Wesson's new management has done a good job getting competitive new products to market and controlling expenses, leading to share gains on top of industry growth. SWHC grew revenues 20% in 2012, 43% in 2013, and 26% in the first quarter of fiscal 2014, while more than doubling operating margins. Background checks continue to be strong, and Smith & Wesson is trading in deep value territory at an 8.4 P/E and 22% earnings yield. If this is not a bubble and strong gun sales are here to stay, this is one very cheap stock.
Performant Financial (PFMT) - 26% growth
Performant provides services that help clients identify and recover delinquent or defaulted accounts and detect payment fraud. Basically they service two industries: Student Lending (about 65% of revenues) and Healthcare (33%). Both segments have delivered excellent revenue growth recently, and most estimates have Performant growing 15% over the next several years. The P/E is 18, cheap for that kind of growth. Here is an excellent Seeking Alpha article that does a deeper dive into the business.
Can anything stop Questcor? This perennial MFI stock has rocketed from under $5 in 2009 to over $65 today, while doubling revenues two years in a row and most recently, delivering another 64% revenue growth. Questcor operates on the back of a single, un-patented drug called Acthar that has been approved for several very specialized conditions (and used off-label for others). The stock is extremely volatile, as investors rightly wonder how long Questcor can get away with charging so much for Acthar and racking up such huge growth before competitors step in - but it hasn't happened yet! The stock meanwhile still trades at a reasonable 18 P/E and 9% earnings yield.