For the past 15 years, one type of investing strategy that has beaten the broad stock market is growth—specifically, buying fast-growing companies at high prices and hanging on as they rise even higher. So-called growth stocks have returned an average of 17% annually since 2009, two percentage points more than the S&P 500.
But top growth-fund manager Brian Demain, CFA, says that, because of a dramatic shift in the world, these types of stocks are facing headwinds now. A new era of higher interest rates since the end of the COVID pandemic makes companies with sky-high valuations a lot riskier.
But this doesn’t mean that you have to give up on innovative, fast-growing businesses. Instead, Demain suggests pivoting to what he calls “smart growth.” His portfolio is full of lower-risk stocks that can offer growth at a sustained pace for long periods without gut-wrenching volatility. This strategy is particularly valuable now that investors have pumped up the valuation of many speculative stocks, making them vulnerable to crashes.
Bottom Line Personal asked Demain how he selects low-risk growth stocks…where he’s finding them now…and what are some of his favorites.
I started my investing career in 1999 just a few months before the dot-com bubble burst. The NASDAQ index, full of fast-growing tech companies, dropped more than 75% by 2002 and didn’t recover and reach new highs for 15 years. I had a front row seat to this financial carnage. What I learned: Growth investing isn’t about finding the fastest-growing companies. It’s about owning wonderful businesses that can expand and compound their value for years through all different types of economic and market environments. Smart growth stocks have four characteristics…
Sustainable growth. The companies I look for don’t need to grow earnings and revenues by 20% every year. I want to see consistent single or double-digit growth, strong free cash flow and the ability to finance their own expansion without taking on large amounts of debt. I’m finding these types of companies now in areas such as medical diagnostics and equipment, which is benefiting from the rapidly graying populations in developed countries…and US industrial stocks, which are experiencing a renaissance as geopolitical tension around the world causes companies to bring production and manufacturing back to US shores.
Large moats. Many of the companies I own are conglomerates with multiple businesses serving a variety of niche end markets, each of which they dominate. Since most of the competition in these niches are from smaller competitors, the companies have an enduring advantage and can continue to increase market share—in other words, they have large moats because it would be difficult for a competitor to disrupt the company’s business model. I also prefer businesses that are “sticky,” meaning they retain customers because it’s either too expensive, inconvenient or undesirable to switch to a competitor.
Savvy management. The CEO should act in shareholders’ best interests and allocate capital well, making smart acquisitions. The board of directors should hold top executives accountable for company results.
Reasonable valuations. Revenue and earnings growth are the strongest drivers of value creation for companies over time. But I’m very careful about what I pay for these stocks, especially in the current environment when market valuations are stretched. My fund’s average price-to-earnings ratio (P/E) is 18.3 versus about 27 for the overall market.
The following six stocks are in my fund’s portfolio now…
Boston Scientific Corp. (BSX). The medical device company is famous for inventing the coronary stent, a tiny metal mesh coil that keeps blood vessels feeding the heart from clogging. That’s just one of hundreds of minimally invasive products that Boston Scientific supplies to hospitals and clinics, including devices to diagnose and treat gastrointestinal and urological conditions, defibrillators, pacemakers and brain-stimulation systems. The company had a few rocky years during the pandemic, as patients cut back on surgeries and procedures, but now it is generating above-average growth in key divisions. One potential blockbuster: The FDA just approved a Boston Scientific treatment for irregular heartbeat called pulsed field ablation, which uses short, high-voltage electrical impulses to remove damaged heart tissue. Recent share price: $79.47.*
Constellation Software (CNSWF). This Toronto-based holding company is the top stock in my fund’s portfolio. It often is referred to as a Canadian Berkshire Hathaway because its founder and president, Mark Leonard, acquires and operates scores of undervalued software companies serving niche markets. Example: Constellation Software’s products help mass-transit agencies run their transit systems…country clubs keep track of its golf tee times and food and beverage operations…and the mortgage industry to price loans nationwide. The company is built for acquisitions, with a fortress-like balance sheet and ample cash flow that can be used to buy more small software firms. Since Constellation Software went public in May 2006, its stock is up nearly 27,000%. Recent share price: $3,199.
GoDaddy (GDDY) is one of the world’s best-known domain registrars, leasing more than 84 million website domain names to consumers and small businesses. This core product provides ultra-reliable revenues because customers tend to renew their domain names year after year. GoDaddy also sells an ever-expanding range of add-on products and services for websites such as design, marketing, security and business-productivity tools. In 2021, the company acquired the online-payment software firm Poynt, which allows customers to make and accept payments via websites and through e-mail and text messages. Recent share price: $164.17.
Liberty One Formula Group (FWONA) controls the commercial and promotional rights to the Formula One Grand Prix, a series of 23 races on five continents. Teams compete in turbocharged race cars that can accelerate from zero to 100 miles per hour in about two and a half seconds. The company, a subsidiary of Liberty Media, has reinvented the sport, launching races in Las Vegas, Miami and Shanghai to broaden US and Chinese interest and is negotiating lucrative contracts with advertisers and broadcasters. Recent share price: $69.79.
W.R. Berkley Corp. (WRB). The insurance holding company owns 55 “excess and surplus” businesses that focus on complex, hard-to-insure commercial markets, ranging from race horses and cannabis dispensaries to zoos and summer camps. It is a leading provider of insurance for universities, underwriting policies that protect against student and faculty injury, damage from cybercrimes, theft of expensive equipment and allegations of wrongful employee termination. The eclectic nature of the policies allows W.R. Berkley to generate some of the industry’s best underwriting profit margins. And because it has low exposure to catastrophe risks such as natural disasters and weather events, W.R. Berkley’s earnings tend to be less volatile from year to year than standard casualty insurers. The company is benefiting now from a hard market, an environment in the insurance industry where pricing favors insurers, which can then hike premiums. Recent share price: $58.30.
WEX (WEX) is a financial technology company that offers highly profitable payment solutions in several niche markets. Its largest business is providing charge cards to 19 million long-distance trucks and rigs for refueling at gas stations. Trucking fleets need to guard against corporate fraud, making WEX, which collects and monitors data, essential. In the future, WEX executives believe the company can generate as much revenue from an all-EV fleet as it does from gas-engine trucks today. The company’s other businesses are equally critical. WEX is now the fifth-largest custodian in the US for health savings accounts, and nearly half the industry uses its benefits software. Its corporate payment division offers business-to-business payment processing and corporate travel-monitoring services. More than 80% of WEX’s revenue comes from services that are consistently renewed year after year. Recent share price: $187.25.
*Performance figures are from Morningstar, Inc., as of August 26, 2024.
