Opinion: Market-beating money managers offer tips on where to put your money now
With a fully valued U.S. market, look at defense names or companies in other countries
Eight years into a bull market with U.S. stocks fully valued, an untested president in office, and potential hot spots dotting the globe, these are tricky times to invest.
It helps to have the smartest people in the room on your side. To find them, I turn to mutual-fund managers who beat the markets over the past three and five years. This is a bigger hurdle than you might think, since almost 90% of fund managers fail this test.
I recently met with two who make the grade to discuss big-picture risks and some of their favorite names. Of course it’s better to learn to fish than to get a fish, so I also gathered tips on how they beat the market. Let’s take a look.
It’s all about earnings
Can U.S. stocks push higher? It all comes down to earnings. With the market fully priced, gone are the days when we can rely on simple valuation catch-up for gains. “If we can sustain even one-third the earnings growth we witnessed in the first quarter, the market should be fine,” says Rob Lanphier, manager of the William Blair Small-Mid Cap Growth Fund WBSIX, +0.23% which beats competing funds’ average annual return by a cool three percentage points over the past three and five years.
Will we get that earnings growth? The chances are pretty good because the U.S. economy is growing at a decent pace, says James Hunt, who manages the Tocqueville International Value TIVFX, +0.06% which likewise trounces competitors by three percentage points annualized over the past three, five and 10 years.
But there are risks. We’ll need progress in Washington on tax reform, repatriation, infrastructure and deregulation, say both fund managers. Investors can’t rely alone on President Donald Trump unleashing “animal spirits.”
Another potential obstacle: Earnings growth will be tougher because we’re late in the economic cycle, and wages are rising. “Margin growth is at risk,” says Hunt.
Hunt prefers foreign markets over the U.S. This isn’t just a professional bias from an international fund manager. Hunt says overseas companies look cheaper. They have more room for margin growth. And economic recoveries abroad are in the relatively early innings. So monetary tightening is further off.
“You have a much longer runway for earnings growth, and better valuations. So markets outside the U.S. are going to do better for the next three years,” says Hunt.
He sees particularly attractive valuations in Japan, Korea, Brazil, the U.K. and even Europe, even though it’s now a popular investment theme. In Europe, you just have to look harder for value and margin-growth potential. But it’s there.
Two European favorites
As a value investor, Hunt likes to shop for good businesses that have fallen out of favor for “the wrong reasons.” He was buying Samsung 005930, -0.04%SSNLF, +11.11% a few years back when investors shunned it on worries that Apple Inc. AAPL, +0.17% would win the smartphone wars. That position is now up about 75%.
Likewise, he bought Bayer AG BAYRY, +0.56% BAYN, +0.92% in mid-2016 when investors sold because they thought a proposed Monsanto merger was stupid. Hunt thought it made sense. The merger went through, and his position is up about 30%.
Hunt favors companies with cash. This puts him in stocks ahead of activists angling for the cash. He avoids countries “where there are no property rights or rule of law.” Yep, that means Russia. He also gets an edge by sifting among smaller companies, meaning under-researched names.
Not surprisingly, his search for the unloved leads him to names with exposure to energy — a hated sector at the moment.
One example is Oceaneering International OII, +4.51% the top supplier of subsea vehicles to oil and gas companies. “The market has decided there is never going to be a need for offshore production and exploration because of what is happening with U.S. shale gas.” Thanks to fracking, the U.S. is one of the biggest producers of cheap oil and gas in the world.
“While we understand the importance of U.S. shale, at some point there is going to be a resumption in offshore activity,” says Hunt.
He admits he’s not sure when. So it’s a plus that Oceaneering has minimal debt and a history of managing expenses well enough to stay cash flow positive even when business is “horrendous,” as it is now, he says.
Another favorite company is in advertising. Because of threats from companies like Alphabet Inc. GOOG, +0.04% GOOGL, -0.05% Facebook Inc. FB, +0.07% and Snap Inc. SNAP, +0.45% which are revolutionizing marketing, a lot of investors now shun traditional advertising agencies. One that stands out as a bargain in Europe is Publicis Groupe SA. PUBGY, -2.41% Publicis is based in France, but it has a global reach. Hunt thinks new management will help turn valuations around.
Searching for moats
At the William Blair Small-Mid Cap Growth fund, Lanphier favors companies with a “durable business franchise.” This can come from natural barriers, or simply because they are the best at what they do. Lanphier likes pricing power, which can come from strong products or brands. And he favors management teams with skin in the game — lots of direct stock ownership. (Similarly, he thinks a pay structure that gives his own team an ownership stake helps him retain top talent.)
Vail Resorts Inc. MTN, +0.20% fits the bill. Vail owns popular ski resorts like Vail Mountain in Colorado, Perisher Ski Resort in Australia and Whistler Blackcomb Resort in Canada. The barrier to entry? It’s expensive to build a ski resort, and there’s a limited number of ideal locations. Vail plans to grow by purchasing more resorts in Japan, Europe and elsewhere. Because it has prime resorts, Vail can regularly increase prices.
Next, Lanphier highlights auto-salvage auction company Copart Inc. CPRT, +0.64% It has a protective moat in that it would be tough to replicate Copart’s online car-auction platform.
The company benefits from two sector trends. One is that cars are getting more sophisticated because they contain more electronics. In turn, insurance companies are quicker to write them off after accidents because it’s so expensive to repair damaged electronics. Unfortunately, another trend that benefits Copart is the rising number of accidents related to texting while driving.
Copart has above-average expected earnings growth, but a market multiple of about 21 times next year’s earnings.
If you follow either of these managers into these stocks, remember to be patient. Both buy stocks with a horizon of several years.