Cashing In on Fast-Growing Small Caps

If you had been prescient enough to invest in Amazon.com when it went public 20 years ago and was still just an online bookseller, your investment today would be worth 500 times more. You probably didn’t, but you can console yourself with the knowledge that for every upstart that goes on to conquer the world, many more fizzle out. That makes small, fast-growing firms especially well suited for funds.

In recent years, few have done a better job navigating these treacherous waters than Hood River Small-Cap Growth (HRSRX). The fund has outpaced the small-company Russell 2000 Growth index in each of the past six cal­endar years (including the first half of 2017). And over the past five years, it handily beat the large-company-oriented Standard & Poor’s 500-stock index.

In charge of Small-Cap Growth are Robert Marvin and Brian Smoluch, who have been with the fund since its 2003 launch, and David Swank, a comanager since 2009. Focusing on stocks with market values of less than $4 billion, they seek companies they believe will boost earnings per share by 15% annually over the next three to five years.

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After identifying these potential winners, the managers talk with executives, suppliers, customers and competitors to identify high-quality companies that Wall Street analysts are underestimating. If analysts expect a firm to earn, say, $1 per share, that projection is already reflected in the price of the stock, says Smoluch. “We’ll invest if we think it will be $1.50,” he says. Aiding the trio is what they call a “research gap”—the growing tendency of Wall Street firms to focus on large concerns, which makes it easier for diligent managers to uncover attractive small-company stocks.

Take Red Robin Gourmet Burgers. Hood River, which had previously owned and sold shares in the restaurant chain, repurchased the stock early this year after the firm brought in new leadership from fellow restaurant operator Brinker International. Those execs, says Marvin, helped boost Brinker’s profit margins sharply, and they could well do the same for Red Robin. Analysts weren’t baking the improved outlook into their earnings estimates, so the fund snapped up the stock. Since then, the shares have surged by 23%.