Research work · 2024
Practical Applications of Enhancing GARP Investing: Creating a New and Improved PEG Ratio
Andrew H. Cohen, Feng Dong
Practical Applications
Abstract
In Enhancing GARP Investing: Creating a New and Improved PEG Ratio , from the Winter 2023 issue of The Journal of Wealth Management, Andrew Cohen of Old Dominion University and Feng Dong of Siena College introduce a new financial ratio that outperforms the widely used PEG ratio for implementing a growth-at-a-reasonable-price (GARP) investment strategy. They call the new ratio the “enhanced GARP ratio.” It differs from the PEG ratio in three key respects. First, it uses a company’s unlevered free cash flow instead of earnings as the primary measure of performance. Second, it treats research and development expenditure as a capital asset rather than a current-period expense. Third, it uses projected future earnings growth rather than historical earnings growth. The authors backtested the enhanced GARP ratio against the PEG ratio over the period January 2007 through August 2022 by sorting Russell 3000 stocks into deciles based on the ratios. The top decile for the enhanced GARP ratio had annualized active returns of 8.49% compared with annualized active returns of just 3.54% for the PEG ratio.