Introduction
The debate surrounding value investing versus growth investing has been a longstanding topic in the investment community, predating the introduction of factor investing concepts. With the increasing adoption of investment style boxes, value and growth strategies have naturally evolved as extensions of asset allocation beyond the traditional market portfolio. These two characteristics serve as fundamental pillars for assessing the performance of investment strategies. For several decades, utilizing value and growth, combined with size exposure in attribution analysis, has been a prevalent method within the investment community for classifying various investment styles.
This paper will present a novel investment strategy that occupies the space between value and growth: the growth at a reasonable price (GARP) strategy, specifically from an Australian market participant's perspective. Through a review of relevant research findings, the essence of the GARP strategy will be clarified by explaining how it differs from traditional value and growth strategies and by identifying key metrics for constructing an effective GARP strategy.
Valuation Metrics as Growth
The conventional understanding of growth investing posits that growth is the opposite of value. Traditional value investing is characterized by investing in low-valuation stocks, as defined by price-to-earnings (P/E) and price-to-book (P/B) ratios. Conversely, growth investing typically involves high-valuation stocks. This distinction originates from the Fama-French Three Factor Model, which classifies stocks based on their P/B ratios. In the Fama-French Three Factor Model, the high minus low (HML) factor represents the average return of two value portfolios minus the average return of two growth portfolios, where value portfolios consist of companies with low P/B ratios, and growth portfolios consist of those with high P/B ratios.
However, this definition of growth can be misleading, as it implies that growth is merely the opposite of value. A purely high valuation strategy does not encompass the full spectrum of growth investing. Growth investors focus on companies with growth characteristics, particularly fundamental growth indicators such as sales and earnings. They consider that growth opportunities may not be fully reflected in current prices, leading to expected excess returns on stocks in the future. Valuation is as important to growth investors as it is to value investors.
To illustrate this distinction, we can compare valuation and style indices in the U.S. market. S&P Dow Jones Indices (S&P DJI) has offered style indices for decades to measure the performance of value and growth stocks using a style box approach. The S&P 500® Pure Growth and the S&P 500 Pure Value are two indices designed to track the performance of stocks exhibiting the strongest growth and value characteristics through a style-attractiveness-weighting scheme. Both indices utilize a two-dimensional sorting method, where each security is assessed based on both value and growth metrics. Stocks are then assigned to value, blend or growth categories based on their relative rankings in these metrics. In this style box approach, value metrics are defined as a composite of book value-to-price, earnings-to-price and sales-to-price ratios, while growth metrics comprise earnings growth, sales growth and price momentum.
