Profit from "Anti-Momentum Investing" with Baron Small Cap
The more things change, the more they stay the same. Take Baron Small Cap (symbol BSCFX). Since the fund's 1997 launch, the same manager -- Cliff Greenberg -- has run the show, but assets have grown from virtually nothing at the fund's launch to $4.2 billion today. The number of stocks in the portfolio has climbed to 93 at last report, from 50 at the end of the fund's first year. But the strategy -- to invest in small, growing businesses that are reasonably valued -- is unchanged. "Back in the early days, there was more of a go-go attitude to the fund," says Greenberg. "Now it's a little tamer, but the methodology has stayed the same."
Over the long haul, that strategy has worked reasonably well. The fund's 9.6% annualized return over the past ten years puts it in the top 35% of the small-company-growth category (all results are through October 24). Over the past year, the fund, a member of the Kiplinger 25, gained 11.4%, putting it in the top 26% of its peer group.
Greenberg's mandate is growth -- it's what the fund shop founded by Ron Baron is known for -- but valuation matters, too. "I am, and the firm is, price sensitive about when we buy," says Greenberg. He'd rather let cash build than put it to work if prices get too rich, because buying at high prices is "a loser's strategy." In fact, with assets at $2.6 billion, the fund closed to new customers in April 2005 mostly because, Greenberg says, new cash coming in was swamping the portfolio. Cash levels approached 15%, but with the market performing well, Greenberg was disinclined to buy then. The fund reopened in August 2006.
Greenberg and a team of 19 research analysts evaluate each company in the portfolio to assess how much each is worth and how fast its profits can grow. And they visit each company. "I need to get a good idea of them on their turf," Greenberg says. He and his analysts think more like owners and managers of a business than investors. During their sit-downs with company officials, for instance, their questions focus more on strategy: Where is the business going? How will you get it there? -- and less on what happened last quarter or what will happen next quarter.
Finding small growth companies that are trading at discounted stock prices is not the easiest thing to do, so Greenberg often trolls for ideas in so-called special situations and fallen angels. Special situations can arise in the case of spin-offs, mergers or management changes; a fallen angel is a once-great growth company that's hit a bump and seen its stock fall. In both cases, he's looking for an underappreciated stock that's poised for a turnaround. "It is anti-momentum investing," says Greenberg.
One such recent bet was BJ's Restaurants, a Huntington Beach, Cal.-based restaurant chain. From November 2008 through January of this year, the stock was on a roll. But in January, the company reported a slowdown in monthly sales at existing restaurants (a traditional measure for retailers and restaurant chains). Growth investors dumped the stock, pushing the price down 30% between the end of January and June. That's when Greenberg started to buy the shares.
BJ's currently has more than 120 restaurants, and Greenberg says it has the potential for 500 to 600 over time. "It's opening stores at a rapid clip, which will allow for continued good earnings growth," he says, The company charges moderate prices -- diners pay about $12 to $13 per meal -- which is a good thing in a weak economy. Greenberg says he expects the company to generate annual earnings growth of more than 25% for "the foreseeable future."
The fund focuses on companies with market capitalizations of less than $2.5 billion, but the average market cap of the fund's holdings is at that level. That's because although Greenberg owns a handful of companies with market caps of about $100 million, he also holds some with market values of more than $10 billion -- hardly anyone's definition of a small company.
When Greenberg buys, he tends to hold for a long time. The fund has an annual turnover rate of 33%, which means Greenberg typically holds onto a stock for about three years. That's far longer than the one-year average holding period of the typical small-company-growth fund.
Consider Liberty Media, a Greenberg holding that has a market cap of more than $13 billion. In the midst of the 2008 financial crisis, the stock dropped after chairman John Malone sold some of his stake in the firm. "That freaked out the investing world," says Greenberg. But for him, it was a signal to buy. The Baron manager picked up shares at $14 to $15 in late 2008 at a time when he thought the business had a per-share value of closer to the mid $20s. Shortly afterward, Liberty Media made a timely investment in satellite radio -- in 2009, the company extended a multimillion dollar loan to SiriusXM as it teetered toward bankruptcy, in exchange for a 40% stake. Liberty shares now fetch $111.84. "That was one of the great all-time investments," says Greenberg. And he thinks the stock still has room for more appreciation.
One reason Baron Small Cap has lagged the Russell 2000 index over the past year is that some of the companies it holds have significant exposure to Europe. Shares in Fossil, the fashion accessories company, fell 42% in the second quarter of 2012, mostly because of weak sales in Europe and Asia. Concerns about Europe also dragged down Cognex, a maker of machine vision products. "Unresolved economic issues -- the euro-zone debt, the U.S. fiscal cliff and the Presidential election -- weighed on the market, and on small stocks even more so," Greenberg says.
Lately, he's been turning toward technology and consumer stocks. A few are newly public companies, including Forum Energy Technologies, an energy-services company that Greenberg bought upon its initial public offering in April. And he's made a bundle with Guidewire Software, a provider of software systems for insurance companies. Greenberg bagged a 75% return in just a few weeks by buying and selling the stock after it went public in January 2012. Then he piled into the stock again in May 2012 -- those shares have since gained 17.5%.
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