Legendary fund manager Peter Lynch became famous for an investment strategy called Growth at a Reasonable Price (GARP). While Lynch retired as manager of the Fidelity Magellan Fund in 1990 at only 46 (a testament to his success), the GARP strategy is still valid and can be applied today to stocks such as Super Micro Computer Inc. (NASDAQ: SMCI), Cohu Inc. (NASDAQ: COHU) and STMicroelectronics NV (NYSE: STM).
GARP is an investment strategy that identifies stocks with both solid growth prospects and reasonable valuations. That means finding companies that are expected to grow earnings and revenue at a faster clip than the overall market but which are not overvalued relative to industry peers or their own historical valuation metrics.
Characteristics that GARP investors look for include a track record of consistent earnings growth, as well as a P/E ratio that’s below some of the sky-high ratios you’ll find with many fast-growing techs, even as their prices drop.
Here’s a look at what makes three stocks potential candidates for investors interested in growth but who are leery of overpaying.
Super Micro Computer
Super Micro Computer designs and manufactures servers, storage systems, and other gear for manufacturers who slap their own labels on products.
It has several characteristics that make it a potential GARP stock:
- Growth potential: A previous track record is often a precursor to further growth. You can study its financials on MarketBeat and see a history of increased revenue. SMCI has a three-year revenue growth rate of 26% and a three-year earnings growth rate of 50%. The company also has strong growth potential in the data-center market, which is expected to show strong expansion in the coming years.
- Reasonable valuation: The company's current P/E ratio of 9 is below many other techs, indicating that the stock may be undervalued.
- Strong financials: SMCI has a strong balance sheet, with a debt-to-equity ratio of 10 and a high return on equity at 25%.
The stock is currently extended from its most recent buy point above $95.22 but is worth keeping an eye on, as it may be buyable again with another moving-average pullback.
Poway, California-based small cap, makes test and inspection equipment for the semiconductor and electronics industries. In addition to selling gear, Cohu also provides services, including customer training, technical support, and equipment maintenance.
Cohu is a worthy candidate under the GARP category for several reasons:
- Growth potential: Cohu's revenue and earnings growth rates have been impressive in recent years. Its three-year earnings growth rate is 219%, not exactly a number you can find fault in. Revenue grew at a rate of 18% in that time.
- Reasonable valuation: Cohu's P/E ratio is below the average within the semiconductor gear industry. That’s a sign that the stock may be undervalued relative to its price potential.
- Positive industry outlook: The semiconductor industry is expected to continue growing over the next few years, driven by trends like AI and 5G technology. This could benefit Cohu, which provides critical testing and handling equipment for semiconductor manufacturers.
A look at Cohu’s chart shows the stock hitting resistance between $38 and $39 on three occasions in recent weeks. Its February 16 earnings report didn’t provide a catalyst for a rally, although remaining in a holding through market turbulence in recent weeks is a good sign that institutions aren’t inclined to bail out.
Switzerland-based STMicroelectronics designs, develop, manufactures, and markets a wide range of chips for use in the automotive, telecommunications, and industrial markets. Its products are found in red-hot applications, including wireless connectivity and AI, as well as power and energy, security, and others. Apple Inc. (NASDAQ: AAPL), Tesla Inc. (NASDAQ: TSLA) and Microsoft Corp. (NASDAQ: MSFT) are among its customers.
Here are some characteristics that make STMicroelectronics a GARP stock to consider:
- Strong growth prospects: STMicroelectronics boasts a diversified product portfolio, with exposure to several high-growth areas such as automotive, industrial, and the Internet of Things (IoT). The company is geared toward innovation, which could put it in a good position to benefit from new tech trends.
- Stable financial performance: The company has one of the best revenue growth records, with sales rising at double-digit rates in the past eight quarters. Earnings increased at double- and triple-digit rates during that time. Its three-year revenue growth rate is 20%, while its three-year earnings growth rate is 62%. This kind of revenue and earnings stability gives institutional investors a sense of security and confidence about a company’s future prospects.
- Reasonable valuation: STMicroelectronics’ P/E ratio of 12 is lower than the average within the semiconductor manufacturing industry. That’s a clue that the stock may be undervalued, especially when you consider its growth prospects. In addition, the company also has a healthy dividend yield of 0.4%, giving incentivizing investors with another source of income.
MarketBeat analyst data for STMicroelectronics show a “moderate buy rating with a price target of $53.50, a potential upside of 7.62%. Watch for the stock to clear resistance above $50.81 in heavy trading volume, as that may precede a new rally.