Investing is simple – it’s people that make it difficult

Human beings are emotional creatures, which is unhelpful when it comes to investing. Why? Because emotions distract humans from what investing is fundamentally about: paying an appropriate price for a share of future cashflows.  

If two companies are trading on the same valuation, it makes sense to buy the one whose profits are growing faster. If two companies are increasing their profits at the same rate, it makes sense to buy the one trading on a cheaper valuation. It sounds simple when I put it like that. I would argue, that’s because it is.  

So why doesn’t everyone invest with this in mind?  

The genesis of SmartGARP 

We all want to hold stocks exhibiting GARP (growth at a reasonable price) characteristics. The problem is finding them. How can you tell the difference between a cheap company capable of growing ahead of the market for a sustained period and one that can only manage it for a couple of quarters at best?

SmartGARP was developed to answer this question. I originally created the tool while working as a strategist at an investment bank to help my colleagues screen stocks for the eight factors that ultimately drive returns¹.  

At the time, they all agreed that the characteristics highlighted by SmartGARP were what really mattered when choosing investments – “in principle”. The reason this qualifier was necessary was because although my colleagues agreed with me in theory, in reality they had no intention of following the program’s instructions. 

Why? This is where emotions clouded the issue. What often happened with the brokers I worked with was that the more they looked at a company in detail, the more they focused on these details and why that company was the exception rather than the rule. The trouble was that in aggregate they ended up with so many exceptions that the rules were well and truly broken.  

“I wouldn't quite do it like that” 

This was the late 1990s and the era of the Dotcom Bubble, which admittedly offered an extreme example of what can happen when emotions override reason.  

But 25 years later, whenever we try to explain the benefits of our process to other fund managers, we often hear the same sort of response: “I agree with you, Philip, but what you say is too simplistic.” Or: “In principle, yes, but in practice I wouldn't quite do it like that.” 

Instead, they will aim to find an industry that is growing faster than average, a management team more capable than its peers, or a company with an unappreciated facet that can take it to the next level.  

There’s nothing wrong with investing in this way. But again, it tends to lead investors to justify the exception of a stock they have fallen in love with or to join the safety of the herd. 

The latter course of action is especially prevalent in our industry. SmartGARP points us away from the stocks everyone else owns, meaning we often go through periods when we underperform investors who make few major calls away from the benchmark. The median fund manager tenure is less than four years², so this isn’t an industry where it pays to stick your neck out.  

But where does this mentality lead to? In Europe, active managers reduced their value exposure to extreme lows just as cheap sectors began to deliver growth. However, these managers could not see the potential in the stocks that were left behind as that would involve leaving the comfort of the herd.  

Active funds P/E vs index funds (Europe ex UK universe)

Active funds performance vs index funds (Europe ex UK universe)

Why shares in Novo Nordisk fell 

Think of it like trying to lose weight. Since everyone knows how to do this – eat less and exercise more – the concept of obesity shouldn’t exist. But a set of principles is little match for a slice of pizza when you should be eating lettuce or a heated car seat when you should be walking through the rain.  

A pedant might suggest the advent of weight-loss drugs complicates this analogy. We would say it strengthens it.  

When Novo Nordisk introduced semaglutide (Ozempic) for the treatment of diabetes in 2018, excitement began to mount about the potential application in treating obesity. The pharmaceutical company returned 400% between 2018 and mid-2024. 

But while profits grew during this period, they lagged well behind the valuation, with the P/E ratio moving from 22x to 51x. 

Novo Nordisk would have had to carry on growing for a number of years to justify such a multiple. We didn’t need to waste time working out how long exactly – the company’s low SmartGARP score just pointed us towards better opportunities elsewhere.  

This meant that when competition from US pharmaceuticals led sales growth of its weight-loss drug to reverse and the company’s share price to fall by more than 70%, we were largely able to sidestep the collapse in a stock that at one point made up close to 5% of our European fund’s benchmark.

What stocks does SmartGARP like? 

So, what stocks do we like? Well, we could tell you about our five biggest holdings, which are growing faster than the market while trading at a cheaper valuation. But in all honesty, our SmartGARP tool might have told us to sell one or two of them within six months. As a case in point, just three of our top 10 holdings at the start of the year retain their place on the list today.  

Other fund managers with a long-term, buy-and-hold strategy may argue this is indicative of a fickle, short-term approach. We would argue the opposite. While they put their faith in individual companies, we put ours in the long-term drivers of returns.  

In other words, when the facts change, we change our mind. What does your fund manager do?