A few words on my investing style...
After thrashing through the growth, value and momentum camps, I've come to favor the GARP, or Growth At a Reasonable Price, methodology made popular by famed investor Peter Lynch among others. The single most important question to ask yourself as a GARP investor is, how many dollars are you willing to pay for $1 of growth?
My initial screen for stocks looks like this:
- 3 year average EPS growth > 15%
- 3 year average revenue growth > 10% (to convince me the earnings aren't an accounting fiction)
- P/E < 20
- Debt to Equity < 1
- Net Margin > 15%
- Return on Equity > 15%
Working from this short list of candidates, I divide the P/E of each stock by its growth rate to get its trailing PEG (price to earnings growth) ratio. Some investors prefer to use projected growth rates to determine the PEG but I don't trust analysts so I assume history repeats until it doesn't. In any case, the PEG ratio is highly relevant when constructing a GARP buy list. .5 or lower is fantastic. I view a valuation like this as paying fifty cents for a dollar of growth. 1 is not as exciting but acceptable. Anything higher and I'm not interested. Who wants to pay a buck fifty for a dollar of growth? Yet if you buy the S&P index or any number of high-flying cult stocks, that's exactly what you're doing!
While low debt is self-explanatory, strong net margins and return on equity shift the odds in my favor that management can continue the growth rates which attracted me to the stock in the first place.
Beyond the numbers, there are qualitative factors I consider. Does the business have a competitive advantage? Generate recurring revenues? Warren Buffett favors simple businesses that make widgets and sell tons of them. I also want to know if the company is shareholder friendly. Is it buying back shares? Paying a dividend?? These are all important questions that seperate the truly great GARP stocks from the value traps.