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It’s great to try to learn from high-profile investment masters such as Warren Buffett. But don’t make the mistake that we in the media make by focusing too much on Buffett and a few other legends.
Otherwise, you’ll miss out on key investing lessons from other pros with stellar records, especially those in the investment business in more recent years.
Consider Josh Bennett and his team at Alger Weatherbie Specialized Growth Fund
ALMAX,
Never heard of them? Let me bring you up to speed. Trust me, it will be worth your time. I share six key investing tactics, below.
But first, the numbers. This fund is up an annual average of 25.5% over the past five years. That means Bennett and his crew beat their Russell Mid Cap Growth index benchmark by 5.9 percentage points, annualized, during that time, according to Morningstar.
Bennett has worked at Weatherbie Capital since 2007. His shop was bought by Alger Associates in 2017. The fund has $1.6 billion in assets, and it carries a 1.27% fee.
Lesson 1: Stay loyal to your system
Bennett attributes key tactics, described here, to the “Weatherbie way,” developed by Matthew Weatherbie and his team in the mid-1990s. Why change, if they work?
“Stick to your knitting when a process is proven and time tested,” Bennett told me in an interview.
This sounds too simple to include, but never forget it. Many investors run into trouble because they succumb to what’s known in the fund business as style drift.
Lesson 2: Go small
Small-cap stocks are a great place for stock pickers for a simple reason: Many investors avoid this end of the market. It has little Wall Street analyst coverage. If there is, it’s by a junior analyst. (Same on the buy side.) That makes small-caps an area where good research can create an information advantage. You’re not likely to get that with a Facebook
FB,
or Tesla
TSLA,
Bennett and his team like to get into companies before their market caps hit $2.5 billion — often in the $1 billion to $1.5 billion range. The average market cap at the fund is $4.9 billion, according to Morningstar, versus $19.5 billion for its mid-cap growth category and $23 billion for its benchmark index.
When researching small-cap companies, Bennett applies the following rules.
Lesson 3: And go for growth
Bennett and his team look for mid-teen to 20% percent annual growth in earnings or earnings before interest taxes and amortization (EBITDA). A good example is Cerence
CRNC,
Spun out of Nuance Communications
NUAN,
in 2019, Cerence offers software that powers speech recognition in virtual assistants inside cars.
This is no small task, given the road noise and background conversations — and the multiple languages and dialects the company has to deal with. Cerence has solid relationships with all the major automakers in the world. Earnings bounce around at this company because of provisions for taxes, but adjusted EBITDA grew 34% in the first quarter to $39 million, and revenue grew 14% to $98.7 million.
Lesson 4: Look for companies with sustainable competitive advantages
Companies with sustainable competitive advantages for Bennett include Upstart
UPST,
which uses artificial intelligence (AI) to support a new approach to credit scores. Upstart deploys AI to assess non-traditional variables like education and employment. The system helps improve the credit quality of loan books at banks, which don’t have the expertise to develop that kind of AI. Banks can then approve more loans, often automatically, with lower loss rates.
Upstart started off supporting the personal loan business. Back in March it moved into car loans by purchasing Prodigy Software, which has a software platform for car buying.
The use of AI in the lending business will be a mega trend. So it’ll be important to continually assess whether Upstart maintains its edge. This is another good lesson.
“The worst thing you can do is find a company that is losing its competitive advantage,” says Bennett.
To track this, Bennett and his team look for clues like a slowdown in growth, a reduction in profit margins or missed earnings forecasts. They also talk with customers and suppliers, and follow trends in trade journals.
Lesson 5: Check for proven management
Following one of the basic rules developed by Matthew Weatherbie, Bennett likes to be in companies that are “past the perils of infancy.” This means the top managers have already suffered bumps and bruises and learned from them.
One tip here is to invest with seasoned managers who have a record of saying “this is what we are going to do,” and then doing it. That’s the case with the fertility benefits company Progyny
PGNY,
led by David Schlanger, who Bennett knows from when Schlanger was CEO of WebMD, from 2013-2016.
Progyny helps employers offer fertility treatment benefits such as in vitro fertilization. It serves over 180 employers in the U.S. across more than 30 industries. First-quarter revenue grew 51% to $122.1 million, and adjusted EBITDA jumped 158% to $17.3 million, though this partly reflected a rebound off a weak 2020 due to Covid-19.
Lesson 6: “Pleasantly boring” can be a thing of beauty
A lot of growth investors flock to hot technology and health-care names. To find companies they overlook, look further afield.
“Quite often you find more interesting businesses outside of those areas,” says Bennett.
A good example is FirstService
FSV,
in property management. Though FirstService offers relatively boring services including banking, insurance, maintenance, security and front-desk staffing, the growth is not at all boring. Operating earnings increased 112% to $33.9 million in the first quarter, on 12% sales growth to $711 million. The company uses its size to drive down the costs of these services, which helps it attract new clients.
Another example is the waste disposal and recycling company Casella Waste Systems
CWST,
which owns scarce landfills in the Northeastern U.S. The company uses its solid cash flow to buy out smaller operators. Adjusted EBITDA grew 16% in the first quarter to $38.8 million. Operating cash flow advanced 117% to $32.1 million.
“We are well-positioned to drive additional acquisition growth through the remainder of the year as our acquisition pipeline remains robust,” said CEO John Casella.
According to the Weatherbie way, this trash company is likely to add some green to your portfolio.
Michael Brush is a columnist for MarketWatch. At the time of publication, he had no positions in any stocks mentioned in this column. Brush has suggested FB and TSLA in his stock newsletter, Brush Up on Stocks. Follow him on Twitter @mbrushstocks.
