What innovative strategies are market participants increasingly exploring to measure growth? S&P DJI’s Jason Ye sits down with Andrew Geoghegan from ausbiz to discuss how GARP, or growth at a reasonable price, is an approach that is gaining traction in the Australian market.
[TRANSCRIPT]
Andrew Geoghegan:
Market participants are increasingly exploring innovative strategies to capture growth, and one approach gaining traction is growth at a reasonable price, or more commonly known as GARP. It presents a compelling case for its integration into investment strategies focused on growth opportunities.
Hello, I'm Andrew Geoghegan of ausbiz, and today, we're diving into how GARP is being applied in the Australian market. Joining me is Jason Ye, Sr. Director of Factors and Dividends Indices at S&P Dow Jones Indices. Jason, what exactly is a GARP strategy, and how does it differ from traditional value or growth investing?
Jason Ye:
GARP stands for growth at a reasonable price. It's a factor-based strategy that measures potential growth opportunities while considering valuation. The traditional value investing is characterized by investing in low-valuation stocks, which are defined by valuation metrics like price-to-earnings and price-to-book ratios. A pure value investor seeks to find stocks that are trading at a bargain price, and the valuation is the key consideration here.
On the other hand, unlike value, growth investing has often been less well defined. Some would argue that high valuation, or, the opposite of value, is equivalent to growth, but, others may argue that they use growth metrics such as earnings growth or sales growth to define it. A pure growth-oriented investor, they might be willing to pay for growth at any price, even if the valuation is extremely high.
GARP sits somewhere in the middle. It blends both approaches looking for companies with growth characteristics, but also taking the valuation into consideration. The GARP strategy was popularized by fund manager Peter Lynch, who believed that growth investing should also consider valuations. And, this dual focus is intended to help investors identify stocks that may not only be poised for growth, but also supposedly priced attractively relative to their growth potential.
Andrew Geoghegan:
And, so how does S&P Dow Jones Indices use the GARP strategy?
Jason Ye:
At S&P Dow Jones Indices, we have been measuring GARP strategies through an indexing approach since 2019. Our GARP indices take a two-step multifactor approach.
We first screen companies that are considered strong growth characteristics, like earnings growth and sales growth, and, then, within this growth universe, we screen for companies with good quality and reasonable valuation.
An index that measures a GARP strategy comes with a few unique characteristics. First, we apply a rules-based systematic approach to avoid active individual discretionary decisions. Second, the index comes with a comprehensive methodology that's publicly available on our website. The index methodology describes the index construction in detail, and that provides transparency behind the strategy.
And, lastly, our index follows a periodical rebalancing schedule, which is designed to ensure that we consistently target the companies that meet the index objective.
Andrew Geoghegan:
And, has a GARP strategy been made for Australia?
Jason Ye:
Yes. We launched the S&P/ASX 200 GARP Index in August 2024. However, the Australian equity market is quite unique in its sector weight and large-cap stock concentration, so, we modified the index construction to better address the characteristics of the domestic market.
Starting with the S&P/ASX 200 Index universe, we first have some basic screening like positive earnings, and, then, we calculate the growth factor and the quality/value factor. The growth factor is defined by combining three-year earnings per share growth and the three-year sales per share growth. The quality/value score combines the ROE and earnings-to-price ratio.
And, then, we first select the top 150 stocks with the highest growth scores, and, within that growth universe, we select 50 stocks with the highest quality/value composite score.
And, these constituents, they're weighted by the float market cap times the quality/value score. They're subject to a 10% single-stock capping, and the 10% single GICS sector relative capping. And, this index is rebalanced on a semi-annual basis in June and December.
Andrew Geoghegan:
How has the S&P/ASX 200 GARP Index performed historically?
Jason Ye:
The index outperformed the S&P/ASX 200 during the full back-test period, with a moderate tracking error. When breaking down the historical performance into different rolling windows, we found that the longer performance horizon, the higher likelihood of the S&P/ASX 200 GARP Index outperforming the S&P/ASX 200.
And, looking at the fundamental data, the S&P/ASX 200 GARP Index has historically had a higher EPS growth and SPS growth ratio, a lower price-to-earnings ratio and a better ROE compared to the S&P/ASX 200, and this is in-line with what the index was designed to target.
A hypothetical combination of the S&P/ASX 200 GARP Index with the S&P/ASX 200 resulted in a better risk/return profile historically than a standalone S&P/ASX 200.
Andrew Geoghegan:
Well, thanks again, Jason, for your insights today. To learn more about how GARP strategies work for the Australian market and S&P Dow Jones Indices' latest data and research tracking markets across Australia, please visit the link below.
