A Winning Fund Manager Shares His Strategy

Thomas Vandeventer likes it when stock investors are scared, as they have been lately. While they cower in the face of rocky markets and shun risky stocks, Vandeventer, manager of the top-performing Tocqueville Opportunity Fund, seeks out attractive opportunities. As those nervous investors shift into stocks of seemingly safe, large, reliable companies, he opts for fast-growing small and medium-sized US companies.

Lately his favorites include a fledgling biotech firm…a software security business that pursues corporate hackers…a veterinary lab that diagnoses heartworm in dogs and pseudo-rabies virus in pigs…and an Arkansas bank that’s gaining a national presence.

These bold investments aren’t right for everyone because the ups and downs of small-company share prices can be hard to stomach. But Vandeventer says small- and mid-cap growth stocks are in a sweet spot right now—they benefit from strong US consumer spending and from having little or no exposure to economic problems in Europe, ­China and other emerging markets.

Vandeventer’s mutual fund, which has outperformed the Standard & Poor’s 500 stock index over the past one-, three- and five-year periods, gained 8% over the past year as of September 30, despite sharp market pullbacks in August and September, while the S&P 500 fell 0.6%. Even more impressive, 16 of his 25 biggest stock holdings had double-digit gains this year.

Bottom Line/Personal asked Vandeventer why this aggressive area of the market shows promise…how he picks winners…and which stocks he finds most attractive now…

Small Has Advantages

Many investors grow fearful of small- and mid-cap growth stocks when the market gets stormy because these stocks often look expensive based on their price-to-earnings ratios (a common indicator of valuation). And it is true that they have performed better than the overall market in the past decade, as measured by the Russell 2500 Index. But we are in an environment now where modest-sized growth stocks can continue to do well. My reasoning: These stocks benefit from a US economy that is likely to expand by 2.5% to 3% in 2015 and keep growing modestly for several years. Also, they are insulated to a large extent from the economic slowdowns in the rest of the world because their business is mostly domestic, while companies in the S&P 500 derive more than 40% of revenue from foreign countries. In addition, large multinational companies are being hurt by the surging strength of the US dollar. ­Finally, while smaller companies can be hurt by higher interest rates, which raise the cost of borrowing money, inflation is so low that rates are unlikely to move up very quickly or very high in the next few years.

What to Look For

I focus on companies with market capitalizations from $1 billion to $12 billion that have these characteristics…

“Best of breed.” That means each is Number 1 or Number 2 in its particular business niche and is ­gaining ­market share from competitors. My picks should be able to increase their earnings growth faster than other companies in their industries, typically by 15% a year or more, over the next three to five years.

A powerful internal catalyst to fuel growth, such as an innovative product or a cutting-edge business model.

Operating in a thriving business sector, helped by favorable government regulations, technology and/or demographics. In fact, more than 80% of my portfolio consists of four of the most promising sectors—biotech and health-care services…information technology (such as cloud-based software)…upscale retailers…and regional banks.

7 Attractive Stocks Now

The following stocks meet my criteria and have the potential to beat returns of the broad market over the next several years…

Acadia Healthcare (ACHC). With 225 facilities in 37 states, the UK and Puerto Rico, Acadia is a dominant player in the field of ­inpatient psychiatric hospitals and addiction-treatment centers. Its growth has been fueled by aggressive acquisitions and government legislation such as the Affordable Care Act, which expands coverage for ­mental-health ­services and substance-abuse treatments. Recent share price: $63.69.

Alnylam Pharmaceuticals (ALNY). This biotech firm was founded by a molecular biologist who won the
Nobel Prize in 1993 for his work with DNA. It is developing a new class of drugs that treats disease at a ­genetic level—interrupting the activities of genes that generate disease-causing proteins. Although Alnylam has no drugs approved by the Food and Drug Administration, it has one of the richest and most exciting pipelines of biotech drugs in FDA clinical trials. Recent share price: $77.40.

Bank of the Ozarks (OZRK). A regional bank with just 164 branches might not be thought of as a growth stock. But Arkansas-based Bank of the Ozarks has become a juggernaut by acquiring the assets of weaker competitors in surrounding states. The strong regional economy of the Southeast has helped the bank build a lucrative business
in commercial real estate loans that’s now expanding into California, New York and Texas. Recent share price: $43.

FireEye (FEYE). This computer-­security firm has earned a reputation as the specialist to call after high-profile corporate data breeches, helping companies such as JPMorgan Chase, Sony Pictures and Target recover from attacks by hackers. But the majority of FireEye’s revenue comes from selling software to corporations to prevent such intrusions. The information-security market is expected to grow by more than 10% annually, from $106 billion in revenues in 2015 to $170 billion in 2020. Recent share price: $31.23.

IDEXX Laboratories (IDXX). The world leader in diagnostic products and services for pets and livestock is benefiting from several intersecting trends. Sixty-five percent of US households now owns a pet, compared with just 56% in 1988. Moreover, spending on pet products and services is expected to increase by 6.5% annually over the next five years. IDEXX has been far more innovative than competitors in developing new products, such as single-use test kits that give veterinarians blood and urine test results in just 10 minutes. Recent share price: $72.03.

Restoration Hardware (RH). Since 2011, this home-furnishings retail chain has nearly doubled its revenue using a daring strategy. Restoration Hardware has attracted customers by opening 15,000-square-foot showrooms and mailing out annual catalogs that have more than 2,500 pages. This year, the company is introducing two new concepts—RH Modern, which focuses on designs that freshen up its signature classical style…and RH Teen, which offers high-quality furnishings for teens. Recent share price: $92.32.

Splunk (SPLK). The software company helps more than 10,000 customers, ranging from Macy’s and Toyota to the US Department of State, analyze the data they collect every day from their websites and from transactions with customers. Splunk’s patented software can reveal patterns of fraudulent activities, as well as customer behaviors that can suggest ways to save money and profit. Recent share price: $54.44.

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