GARP Research focuses on finding high quality stocks we consider to be attractively priced and have the potential to materially appreciate over a two to three year time frame, and oftentimes over a decade or longer. We are proud of our discovery of some of America’s iconic companies very early on in their development, often at contrarian times when sentiment for their business models was distinctly bleak.
There are several elements that come together in preparing our often 20 to 50 page long dense discussions of operations, competitors, and the markets companies serve. One piece is that we do a very thorough job of modeling the various pieces of a company and its competitors. More often than not, we must estimate what is occurring on a sub-segment level. We have very detailed templates that have been developed over three decades that enable us to quickly “deconsolidate” financial statements and still reconcile to corporate totals. Our founder developed insight into this process a decade and a half before GARP Research started, when he was responsible for consolidating financial statements within a large geographic region of a Fortune 500 company with far flung operations and a very complex organizational structure.
Another element is to be oriented towards mid-to-long term strategic issues when making forecasts, despite having a very granular approach to tracking quarterly financial results. This requires an understanding of what capital is needed to be in a particular business, and what competitive advantages and barriers exist. Deeply fundamental questions must be asked and the answers resolved, and in the most productive of our investment ideas, these are at odds with current trends. We have found on more than a few occasions that being contrarian or “early” can have robust rewards if your time frame extends beyond the next few quarters.
We must understand the true causes of growth for a company. We find that simple extrapolation of longstanding trends is often priced into an equity’s valuation, and sometimes secular or cyclical tailwinds can reverse to become headwinds. Knowing all we can discover about the long-term prognosis for market penetration, technological change, and competitive dynamics helps us sort this out.
Finally, we acknowledge that now more than ever, we live in a world of bubble finance, manipulated prices, and doctored views of financial statements. It’s almost passé to stick to conventional GAAP accounting analysis. At GARP, as described in this web site’s essay on valuation and accounting issues, we believe the best way to really have a handle on valuation is to reject most of the adjustments made to GAAP accounting that tend to fatten up earnings. Still, we are known to make positive additions as well as negative modifications. We think our approach is by and large more grounded than analyses based simply on pro forma or EBITDA numbers. We think this is something that has typically been least appreciated when the stock market is exuberant, and that typically the widest divergences between GAAP and pro forma exist in our neighborhood – which is among smid-cap growth companies. We also are most concerned with native return on capital employed, and assessing if corporate reinvestment can create returns as appealing as historical ROI. This requires quite a bit of balance sheet analysis, which we find can yield very interesting insights, in part because this part of financial reporting can be an area of analytical neglect.
Pulling all this together, GARP Research screens a large number of companies and originates several interesting new ideas each year, as well as publishing numerous reiteration reports. We think these can be very rewarding to institutional portfolio managers looking for quality smid-cap stocks with intriguing multi-year risk-return tradeoffs.