If you’re hitting a lot of trades right on the Robinhood trading platform, be careful of hubris.
Overconfidence kills returns.
If you need a little something to spark your humility, consider this investor’s record. John Malooly, who manages the Wasatch Ultra Growth fund
has beaten his small-growth category and the Russell 2000 Growth Index
by an annual average of 11.5 to 19.5 percentage points over the past three to five years, according to Morningstar. The fund is ranked No. 1 in its category for total returns over the past three years, per Morningstar.
If you’re new to investing, let me tell you: You don’t often see such a good long-term record. Few people consistently beat broad indexes, such as the S&P 500 Index
the Dow Jones Industrial Average
or Nasdaq Composite Index
I always wonder what I can learn from performers like these, so I recently talked with Malooly to find out. Here are the key takeaways.
Go for big growth
Malooly likes to have an average revenue growth of 20% in his portfolio. This looks risky because it’s about 8 percentage points higher than his benchmark index, according to Morningstar. But his portfolio is a deliberate mix of supercharged growth names in areas like tech and sectors you don’t normally associate with growth to offset the risk.
In supercharged tech, he favors plays on the “digitization of businesses,” like Zendesk Inc.
in customer-service software. Others here include DocuSign Inc.
in digital-signature documents, Five9 Inc.
in cloud-based call-center software, and HubSpot Inc.
which helps smaller companies use the internet and digital marketing.
Meanwhile, he also goes with “safer” companies that have lower growth, but less propensity to blow up. For example, you rarely see grocery stores in growth portfolios, but he holds Grocery Outlet Holding Corp.
The off-price grocery chain posts 10% sales growth, in part, by enticing entrepreneurial store managers with generous profit splits and lots of operational freedom.
Favor defensive growth
“Just buying fast-growing companies is high risk,” says Malooly. They can get hurt even on a small misstep. One way to cut risk: Avoid debt. “With faster-growing companies, leverage is not an asset,” he says. “They should be self-funding. Fast-growing companies with leverage tend to blow up, and you are not going to see the signs of stress until they blow up.”
He also looks for recurring revenue. About half the stocks in his portfolio have this. “When you get hit in companies that have recurring revenue, you are down 20% to 30%, not completely blown up,” he says.
This can come in the form of subscription revenue like at Paylocity Holding Corp.
which offers cloud-based human-resource-management software. Paylocity serves small businesses hit hard by the lockdown. “But even if they don’t grow next quarter, I’m not looking at them being down 90%,” he says, because of the subscription revenue.
Repeat revenue also comes from follow-up maintenance and supply sales. Here he cites Kornit Digital Ltd.
which sells printers and ink used for “fast fashion” and sports team apparel.
He even finds repeat revenue in biotechnology. The DNA-based cancer-screening tests of Exact Sciences Corp.
get re-administered every few years. “The hurdle to grow is a lot lower than it appears,” he says. Another is Tandem Diabetes Care Inc.
Its insulin pumps have to be replaced every few years.
Otherwise, cut risk by resisting the temptation to chase stocks. And buy when temporary issues knock a good stock down. For example, in May 2019 Trex Co.
reported manufacturing issues in a new line of decks. That seemed like a fixable problem at an otherwise good company, so Malooly bought the weakness. It is now “a double,” meaning the price rose 100%.
Invest for the long haul
Malooly buys names he thinks he can stick with for years. His portfolio turnover is typically a low 17%. To find buy and hold names, Malooly looks for “long duration,” sustainable growth. How to identify this?
Malooly likes companies that can take market share. Here, he cites Silk Road Medical
in specialized cardiovascular surgical equipment, and Inspire Medical Systems Inc.
which sells devices that help manage sleep apnea. Another is Esperion Therapeutics Inc.
which is on the cusp of launching a non-statin therapy for elevated cholesterol.
Malooly also spends lots of time getting to know management. He even hires a private investigator to do background checks and interview former colleagues, bosses and employees. About 10% of the time they yield important results — negative or positive.
Reports on FreshPet Inc.
management helped boost returns.
“The reports on the CEO were ridiculously glowing. Everybody said he is no-nonsense and a winner.” This stock is up 800% since Malooly’s first Morningstar-reported purchases in the last quarter of 2015. (It’s up 635% since I suggested it in my stock letter, Brush Up on Stocks, in April 2017.)
Malooly emphasizes meeting management in person.
“It’s like the difference between going to a restaurant with someone and eating in their house. It is just a different experience.”
On-site meetings also let him witness company culture and how management interacts with others. “We rank all our companies by management team,” he says. “Our best teams tend to do the best over time.”
Malooly also looks for good track records, signs that a management team isn’t a slave to quarterly results so it has the freedom to invest long term, and pay incentives that favor shareholders.
Shop for Covid-19 plays
Malooly believes a vaccine will be key to getting the economy back to normal. He expects vaccine approval for emergency use by the end of the year. But since he’s loath to chase stocks, he avoids the coronavirus-vaccine plays. He’s skeptical of Moderna Inc.
pointing out that early data were based on only a few patients.
“I wouldn’t bet against Moderna, but I am not betting with them,” he says.
Instead, for Covid-19 plays he likes companies that benefit from lasting behavioral change because of the virus. For example, people normally don’t shop for furniture online. But during the lockdown, they had to. And they got used to it. So while Malooly generally avoids companies that compete with Amazon.com Inc.
he likes Wayfair Inc.
which sells furniture online. He thinks people will now buy furniture online more often.
“There will be a sustained change in behavior,” he says.
He thinks Wayfair does a great job of creating its own designs and brands, which makes it harder for customers to comparison shop.
Market commentators on Twitter post lots of snarky comments about young people trading on the Robinhood platform. I think this is great, because it’s nice to see people getting into the industry, and experience is the best teacher in investing.
Another Malooly maxim supports my take. He attributes his fund’s success to experience — and lots of it.
“Two or three of us will go into a meeting and there might 40 to 60 years of small-cap investing experience,” he says.
Malooly contributes 24 of those years.
At the time of publication, Michael Brush owned EXAS and ESPR. Brush has suggested EXAS, ESPR, FRPT, and AMZN in his stock newsletter, Brush Up on Stocks. Brush is a Manhattan-based financial writer who has covered business for the New York Times and The Economist Group, and he attended Columbia Business School. Follow Brush on Twitter: @mbrushstocks.