Investors who focus obsessively on growth stocks - companies that post big earnings per share increases - are looking in the wrong direction for rich returns, according to Frank Caruso, lead manager of the AllianceBernstein Large Cap Growth Fund (APGAX). Caruso, instead, has posted exceptional returns by buying "growth companies" that offer investors long-term growth, he said in a detailed story in Barron's

His $5 billion fund has returned an average of 17.1% over the past five years, better than 93% of the large cap growth funds tracked by independent investment research firm Morningstar Inc., according to Barron's. It also has beaten the Russell 1000 Growth Index over the last one, five and 10-year spans, per the same sources.

Focus on ROA, Not EPS

"EPS is a poor fundamental report card... it doesn't bring in the efficiency of how a company deploys capital," Caruso told Barron's.

For this reason, Caruso uses return on assets (ROA) as his primary metric for success rather than earnings per share. Per Barron's, his fund's top 10 holdings, with recent ROA figures, are: Google parent Alphabet Inc. (GOOG), 12.8%; social networking leader Facebook Inc. (FB), 18.3%; payments processor Visa Inc. (V), 9.8%; health insurer UnitedHealth Group Inc. (UNH), 6.5%; and, computer and smartphone maker Apple Inc. (AAPL), 14.3%.

The fund also owns home improvement superstore The Home Depot Inc. (HD), 18.3%; medical technology company Edwards Lifesciences Corp. (EW), 15.2%; athletic footwear, apparel and equipment maker Nike Inc. (NKE), 18.8%; robotic surgery systems developer Intuitive Surgical Inc. (ISRG), 14.8%; and, programmable device developer Xilinx Inc. (XLNX), 13.0%.

These 10 stocks account for 43.5% of the AB Large Cap Growth Fund's portfolio, as of June 30, per Barron's.

Persistent Return Model

In developing what is called a "persistent return model" to help in the identification and analysis of growth companies, Caruso and his team look at other factors in addition to ROA, Barron's says. The three companies that he chose to discuss in detail were Nike, Facebook and Intuitive Surgical.

Nike

Nike has a history of a high ROA, with an average of 18.2% over the past five years, more than twice the 8.5% average for the S&P 500 Index (SPX), Caruso told Barron's. Nike also is in the process of increasing the automation in its design and manufacturing processes, with the benefits of less reliance on low-cost labor in Asia and reduced lead times, which, in turn, permit leaner inventories. Additionally, Nike is increasing direct-to-customer sales, with wider selections and increased customization.

Facebook

With Facebook, the company is growing so fast that purchases made at what seem to be outrageous valuations look like huge bargains just a few years later, Caruso told Barron's. His team began buying late in 2012 when Facebook traded at around $20 a share and had a trailing P/E ratio of about 150. When compared to current trailing EPS of $3.78, those purchases were at an effective P/E ratio of just over 5. Each year, Caruso says, Facebook starts with a P/E several times that of the S&P 500, then justifies that valuation in a few years' time with rapid earnings growth. (For more, see also: Why Facebook's Value Is Best Among FAANGs.)

Intuitive Surgical

Intuitive Surgical also was added to the portfolio in 2012, based on consistent and improving ROA, which has averaged 14.8% over the past five years, Barron's reports. Caruso sees room for more growth as Intuitive expands internationally and robotic surgery becomes more widely adopted. Intuitive was one of the top five performers among S&P 500 health care stocks in the first half of 2017. (For more, see also: S&P Stealth Performers: Health Care.)

Overweight in Health and Tech

The AB Large Cap Growth Fund has 19.7% of its portfolio in health care stocks, and 35.7% in technology, with little or no exposure to energy and utilities, Barron's reports. The reason is that the first two sectors have high ROA figures, while the latter two are capital-intensive sectors producing low ROA. Cloud networking company Arista Networks Inc. (ANET) is a smaller, younger tech that the fund bought in 2015 at around $60, but now trades at about $157, with a 14.7% ROA, versus 8.2% for chief competitor Cisco Systems Inc. (CSCO). Meanwhile, the fund is underweight in financials, since Caruso and his team do not think of banking as a growth business.

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