GARP: Growth at a Reasonable Price
Fightin’ Words – The first time I was called a GARP manager, I thought it was an insult. However, when I learned what GARP stood for I was immediately flattered. Growth at a Reasonable Price is, in truth, a great way to invest for capital appreciation. It’s also important to make the distinction between a GARP investor and a value investor.
I once read that when Warren Buffett was asked if he was a value or growth manager, he replied: “I am neither and both, I would never invest in anything that I didn’t believe would grow and I would never pay more than I thought it was worth.” We believe that the principle of valuation is one of the most vital attributes that a successful investor has to get right.
Valuation vs. Value Investing
However, valuation is not the same concept as value investing. Value investing is more about acquiring assets for less than they are worth. Valuation measures current price in relation to expected future cash flow or earnings growth. A reasonable valuation is one where the level of expected earnings and cash flows represent a return on investment that compensates for the risk taken.
Buying high future growth at an attractive valuation is the essence of GARP. Since 1991, the average rate of earnings growth for the S&P 500 has been 6.2%. Historically, depending on the prevailing business environment, growth of the average company has ranged between 6-12%. Therefore, for purposes of this article we will define above-average growth to be 15% or better.
Three GARPs based on Fundamentals
Utilizing our Fundamentals-at-a-Glance research tool we will feature three interesting small-cap GARPs. Each of these mighty-mites currently possesses P/E ratios that are below both their historical earnings growth and their forecast earnings growth. Importantly, they each have solid balance sheets with little or no debt and/or good cash flow generation.
Almost Family, Inc. (AFAM) is in our view a strong demographic opportunity. Almost Family, Inc. is a leading provider of home health nursing, rehabilitation and personal care. As our population continues to age, the demand for Almost Family, Inc. and its subsidiaries’ products and services should be strong. Figure 1 below shows that Almost Family, Inc. has generated strong earnings growth over the last decade, has low debt at 22% and trades at a P/E ratio of only 13.7 times earnings.
Figure 1 11yr EPS Growth correlated to Price
Figure 2 below calculates shareholder returns since 12/23/1999 as compared to the S&P 500. There was no lost decade here for shareholders. And note how closely returns correlate to the historical earnings growth shown in Figure 1.
Figure 2 11yr Price Performance History
Figure 3 below shows Almost Family, Inc.’s consensus 5-year estimated earnings growth rate of 20% as reported by eight analysts reporting to FirstCall. The current blended P/E ratio of 13.7 implies undervaluation assuming the earnings forecast is correct. Note that the earnings per share estimates for 2010 is expected to be flat, then accelerate thereafter.
Figure 3 EPS Forecast
EZCORP, Inc. (EZPW) operates chains of pawn shops totaling over 670 storefronts in 13 states and Mexico. Financial stress over the past decade has contributed to strong earnings growth for EZCORP, Inc. Their vision of : “EZCORP will be the preferred provider of short-term cash to the cash and credit constrained consumer – neighborhood by neighborhood” has paid off.
Figure 4 below shows that EZCORP, Inc. has produced strong earnings growth since 2000, has low debt (6%) and a blended P/E ratio of only 11.8 times earnings.
Figure 4 11yr EPS Growth correlated to Price
Figure 5 below calculates EZCORP, Inc. shareholder returns since 12/31/1999 versus the S&P 500. Once again, note how closely returns correlate to the historical rate of change of earnings growth depicted in Figure 4.
Figure 5 11yr Dividend and Price Performance History
Figure 6 depicts a 15% five-year forecast growth rate of earnings by 5 analysts reporting to FirstCall. Their blended P/E ratio of 11.8 implies attractive of valuation assuming the forecasts are accurate.
Figure 6 EPS Forecast
Deckers Outdoor Corp. (DECK) is our final small-cap GARP. Deckers Outdoor Corp. is a designer and producer of high quality footwear. They are the category creator of the sports sandal and luxury sheepskin footwear segments. They have no debt and have produced strong earnings growth over the past decade.
Figure 7 below shows how Deckers Outdoor Corp. has generated strong growth with only modest cyclicality.
Figure 7 11yr EPS Growth correlated to Price
Figure 8 calculates shareholder returns over the past decade compared to the S&P 500. Deckers Outdoor Corp, generated shareholder rewards that were independent of the general market (S&P 500) and strongly correlated to their operating success.
Figure 8 11yr Price Performance History
In Figure 9 we show the consensus five-year forecast for Deckers Outdoor Corp’s earnings as reported to FirstCall by 9 leading analysts. Note that Deckers Outdoor Corp is forecast to have the highest expected future growth of the three, yet still only trades at a blended P/E ratio of 13.5.
Figure 9 EPS Forecast
We believe in a market of stocks rather than a stock market. Consequently, we further contend that it is always a stock picker’s market.
On January 6, 2010, we posted the article: “S&P 500: Modestly Overvalued.” Today’s article covers three small-cap companies that appear undervalued based both on historical and forecast earnings growth.
Small companies carry more risk than larger companies, and consistent with these examples pay no dividends. Therefore, they are most appropriate for the discerning investor looking for capital gains and willing to assume some risk to get them. On the other hand, based on balance sheet strength and valuation these three may represent intriguing opportunities. They certainly are worth a further look and deeper scrutiny.
Disclosure: Long AFAM, EZPW, DECK at time of writing.