Investors looking for fast-growing stocks in an expensive market might want to follow the lead of Mike Balkin and Ward Sexton, managers of the superstar William Blair Small Cap Growth fund, which has outpaced 94% of small-cap growth funds tracked by Morningstar. The two managers recently provided Barron’s with insight into their portfolio selection and a closer look at four of their favorite holdings: Ligand Pharmaceuticals Inc. (LGND), a small health-care company; Codexis Inc. (CDXS), a protein engineering firm; Varonis Systems Inc. (VRNS), a security software company; and, Boot Barn Holdings Inc. (BOOT), a retailer of Western wear and work boots.
As of 10:30 AM EST, 17 August 2018
The William Blair Fund
First launched in 1999, the William Blair Small Cap Growth fund, with its 80-90 holdings, is now valued at $668 million and ranks in the top quartile of its peers for every major trailing time period over the past 15 years. The fund has averaged 19.4% a year over the past three years and has outperformed the Russell 2000 Growth Index by around two percentage points in each of the last 10 years.
While the main focus is on growth stocks, the two managers and their team of nine sector analysts make their picks based on ideas that come from a variety of different places and for a number of different reasons. What makes their strategy unique is that they look for growing companies that have yet to be discovered or are not yet understood by the rest of the market, and they’re “not afraid to be contrarian at times,” Balkin told Barron’s. (To read more, see: How to Profit by Going Contrarian.)
Typically, their holdings fall into the following three categories: traditional growth; undiscovered; and/or fallen growth.
One of the fund's undiscovered companies, Ligand, which develops products with other pharmaceutical companies, was started in 1987 and since that time has become very profitable. Balkin believes the firm is paced to achieve $10 a share by 2021, up from below $6 per share for 2018. That puts Ligand “squarely in the camp of the traditional quality growth names,” says Balkin.
Originally receiving funding from Royal Dutch Shell to use its protein engineering capabilities in order to speed up the production of ethanol, the market lost faith in Codexis when the bottom fell out of the ethanol market. But what Balkin and Sexton understood that the market didn’t was that Codexis’ technology had much wider applications in other industries.
Lacking a wide following from analysts and other institutional investors when Balkin and Sexton first discovered it, the security software offered by Varonis stood out to the managers for its differentiating ability to spot not only external threats but also inside threats, like employees or vendors acting maliciously or accessing prohibited data. They believe the company could grow earnings at a rate of 30% a year for the next three to five years. (To read more, see: The Uptrend in Cybersecurity Looks Poised to Continue.)
Boot Barn Holdings
Having the misfortune of going public just as oil prices were crashing in late 2014, America’s largest retailer of Western wear and work boots would be considered one of the fund’s fallen growth picks. The William Blair team picked up the stock in July 2017 and the share price has more than tripled since, as the company expands its margins on a growing private-label business.