Last week I spent a week at the University of Nebraska attending an Executive MBA Course on understanding innovative methodologies to evaluate management and value companies.
Omaha is the home town of Warren Buffett and the University of Nebraska provides some amazing degrees to study in this field of investing and security analysis.
One of the most interesting parts of the course was where each day we were presented with a challenge to evaluate a particular company with limited facts to determine fair value valuations. Our results were then compared to what Warren Buffett had paid for the same company. Interestingly, some of these acquisitions dated back as far as the 1970's so it provided some fascinating insights.
Over the years, there has been a lot written about the concept of value investing which was made famous by Buffett. The main idea of this philosophy and approach is to to acquire a share at a discount, or as if the share was on sale!
In some cases, one could acquire a share at as much as 20, 30 or even 40% discount to what would be considered its fair market normal price. This difference largely exists due to efficiencies on the market and human behaviour sometimes being erratic.
The traditional value investing methodology really looks to discover companies which are predicable in nature and are steady in nature. They generally have a reasonable rate of return on capital and are companies which are reliable today and also tomorrow.
If you think about the clydesdale horse that pulls the beer cart, it is strong and continues to put one foot in front of the other. The horse is reliable and each day consistently moves along at the same pace with high levels of certainty so that supply won't be disrupted by the chosen source of transport. Generally, the deep value investing approach focuses on traditional industries or areas of business.
The only short fall with this approach is that the companies in a lot of cases are surprisingly in lack of inspiration and general rates of returns are also representative of these industry. These industries might be food and beverage products, manufacturing, specialty clothing, banking, insurance etc.
The other side of the value coin is knows as GARP which stands for "Growth at a Reasonable Price." Essentially it thinks about the similar notion of acquiring a company at either a discount or fair market price that make fundamental sense. The major difference is that this approach however is seeking out companies which have a higher than normal return on equity or historical higher earnings growth projectors which one can easily forecast into the future.
If I contrast this to the clydesdale horse example, this is like a team of dog sled huskies which race across a snow plain. The most amazing thing with these animals is that they can run all day at a steady state of 20 km per hour. They also have the ability to carry reasonable loads. Unlike the clydesdale which plod along, the huskies run with great excitement and enthusiasm.
In reviewing both analogies, both forms of transport allow you to get to your end point and both can have varying loads which are specific to their fields of expertise. The difference is that the husky's rate of pace is in some cases double that of the clydesdale's.
I think the essence of GARP investing as opposed to deep value investing, really explores some of these industries and companies which are in exceptional areas. They also have wonderful long term sector tail winds. If selected correctly, they can also have tremendous rates of returns which in some case double what might be provided from a traditional industry.
Although a GARP company may not be discounted as heavily in the initial purchase, as with the traditional value approach, if the organisation is growing at a significant rate of return over the next 10 years, the final destination point and rate of projection with the impact of compounding can be quite incredible!
If you would like assistance in selecting a GARP company or to discuss this methodology further, please speak to AJ Financial Planning in a FREE no obligation consultation.