5 Great GARP Stocks Based On Discounted PEG

In the equity market, investments always need to be prudently hedged, in order to overcome uncertainties and limit losses related to external shocks. A question that arises often is whether one should resort to a value strategy that seeks discounted stocks or opt for growth investing, in times of extreme market instability.

The investing track of the Oracle of Omaha over the past few decades and his gradual shift from being a pure-play value investor to a GARP (growth at a reasonable price) investor might give us all the answers.

Under the GARP theory, the strategic mingling of growth and value-investing principles gives us a hybrid strategy offering an ideal investment by utilizing the best features of both. What GARPers look for is whether or not the stocks are somewhat undervalued and have solid sustainable growth potential (Investopedia).

GARP investing gives priority to one of the popular value metrics — the price/earnings growth (PEG) ratio. Although it is categorized under value investing, this strategy follows the principles of both growth and value investing.

The PEG ratio is defined as: (Price/ Earnings)/Earnings Growth Rate

It relates the stocks’ P/E ratio with the future earnings growth rates.

While P/E alone gives an idea of stocks that are trading at a discount, PEG, while adding the growth element to it, helps identify stocks with solid future potential.

A lower PEG ratio, preferably less than 1, is always better for GARP investors.

Say for example, if a stock's P/E ratio is 10 and the expected long-term growth rate is 15%, the company's PEG will come down to 0.66, a ratio indicating both undervaluation and future growth potential.

Unfortunately, this ratio is often neglected due to investors' limitations to calculate the future earnings growth rate of a stock.

There are some drawbacks to using the PEG ratio though. It does not consider the very common situation of changing growth rates, such as the forecast of the first three years at very high growth rate, followed by a sustainable but lower growth rate over the long term.

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