When it comes to investing in growth stocks, there are two types of investor. There are those relaxed about paying high prices for the promise of rapid growth. And there are those who hate the idea of overpaying and take valuation seriously.

Over the past three years, Fever-Tree Drinks has been an excellent example of what it means to pay a high price for growth. The high-end mixer and soft drinks business floated at the end of 2014. But its shares have never looked cheap against standard valuation ratios. With a current PE ratio of 73, it’s got the kind of rating that would have value investors choking on their G&Ts.

Yet you won’t hear too many complaints from investors who actually bought Fever-Tree stock over the past couple of years. Fever-Tree has been a consistent over-achiever, smashing analyst growth forecasts at almost every turn. Its share price has soared as a result - paying off superbly for the growth investors prepared to bet that Fever-Tree could (and can) keep delivering.

There are similar examples with varying degrees of extreme prices. Over the past five years stocks like ASOS, Just Eat, JD Sports and Domino’s Pizza have all, at times, offered the promise of future growth but demanded a high price for it.

Sadly, however, stunning success stories like Fever-Tree don’t come around very often. When they do, the powerful momentum that builds in their share prices can deliver stunning returns. But that momentum also means they are prone to sudden drawdowns if (and when) the growth story slows down. This happened at ASOS and JD Sports, and it’s precisely why many growth investors take valuation so seriously.

Growth at a better price

Growth at a reasonable price (GARP) investing was made famous by a fund manager called Peter Lynch. He produced stunning returns while running the Magellan fund for Fidelity Investments (he later wrote the book One Up on Wall Street). In the years that followed, the late Jim Slater introduced a similar growth approach to the British investing masses in his book, The Zulu Principle.

In essence, GARP strategies look to balance a track record of earnings growth with a moderate valuation in stocks that are usually good quality and may already have caught the attention of the market.

At Stockopedia, a screen that models these factors…

Finish reading with a 14 day trial

or Unlock with your email

Already have an account?
Login here