Growth stocks have been on a tear in recent years.
The Vanguard Russell 1000 Growth ETF (VONG) registered annualized returns of 33% for the 12 months through Sept. 18 and 16% for the past 10 years.
Dan Davidowitz is one investor who believes in growth stocks. He’s co-manager of Polen Growth Fund (POLRX) , which has $7.1 billion in assets and an investment minimum of $3,000. Polen Capital overall had $65 billion in assets under management as of June 30.
The fund generated returns of 20% for the past 12 months, negative 2% for three years, 11% for five years and 14% for 10 years, according to Morningstar.
These numbers trailed the Vanguard ETF listed above in each period. To be sure, the Polen fund did outperform the Vanguard ETF in four of the 10 years from 2014-2023.
Dan Davidovitz, analyst and portfolio manager, Polen Capital
Polen Capital/TheStreet
Davidowitz and his colleagues have a strict process for choosing Polen Growth’s stocks. They pick only companies with clean balance sheets and strength in cash flow, return of capital, profit margins and organic revenue growth.
TheStreet recently chatted with Davidowitz about the fund as part of our expert interview series. This is what he had to say, including stock picks.
TheStreet.com: What’s your investment philosophy?
Davidowitz: We have a concentrated portfolio of 20 to 25 stocks (23 right now). We like businesses that can grow their earnings in the mid-teens [percent] or better annually.
They have less risk because they’re the best companies. And mid-teens earnings growth brings mid-teens returns.
Definition of quality stocks
TheStreet.com: Given your focus on quality stocks, how do you define quality?
Davidowitz: We have five guardrails for choosing stocks.
Cash-rich balance sheets with little debt,Excess free cash flow every year,Return on capital of at least 20%,Stable or increasing profit margins, and,Better-than-average organic-revenue growth.
We require sustainability in each of those areas.
That leaves us with a pool of only 200 to 300 companies. We do deep fundamental research to choose among them.
They aren’t always available at great prices or firing on all cylinders. We are constantly iterating our research. We usually buy or sell two or three stocks a year.
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We try to own companies while they’re in a growth phase. But it’s not all fast growth. Some are growing earnings 11% to 12% a year but provide safety. Our average holding period is about six years.
TheStreet.com: Are there any industries or market themes that you particularly like?
Davidowitz: We’re bottom-up investors, looking at individual companies that meet our criteria in a sustained way. There’s usually something that’s pushing them, such as digital advertising that’s driven by companies like Google, owned by Alphabet (GOOGL) .
We aren’t thinking of advertising [as the catalyst], but rather Google growing the opportunity. It’s companies that dominate their industry or very differentiated companies in a highly fragmented market, such as information-technology services firm Accenture (ACN) .
The best companies now tend to cluster in tech, health care and the consumer sector. Great companies are much less prevalent in commoditized industries like financial services, energy and industrials.
We do occasionally find companies in financial services like payments companies Visa (V) and Mastercard (MA) , though I wouldn’t label them as financials.
Downturn strategy, favorite stocks
TheStreet.com: How is the fund protected from a big market downturn?
Davidowitz: When a recession hits, the companies that meet our guardrails tend to avoid going backwards in earnings. They continue to grow. Our portfolio has a balance of growth and safety.
TheStreet.com: Can you talk about three of your favorite stocks?
Davidowitz: 1. Our biggest holding is Amazon (AMZN) . It has some of the most competitive advantages in the world. It has underappreciated earnings growth and a comfortable valuation.
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It has at least three businesses. E-commerce has a profit margin of about 3% to 5%. Amazon Web Services, its cloud division, has a margin of 30%,. And advertising, which is linked to e-commerce, has a 70% margin.
Margins are improving for all three divisions, and the fastest growth is coming where the margins are highest. The whole company’s profit margin is 10%, above pre-Covid levels. And there’s a lot of headway for increases.
2. Software/database company Oracle (ORCL) is our latest addition. We had owned it before, but not since 2019. They had slow growth for a while because they were geared for on-premises service. They were slow to move to the cloud.
Over the last few years they built Oracle Cloud Infrastructure, and are now the No. 4 cloud service provider. They are late to the game, but have done it differently.
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They have small data centers to run public or private clouds. They often set up at customer locations, providing security and making it cheaper and more efficient than others. Last quarter, they had 8% organic revenue growth, and that should accelerate.
3. Adobe (ADBE) , the content management services provider. It dominates the creative software market. There’s a debate about whether generative artificial intelligence is good or bad for the company.
They were early to build AI into their design software. But there also are things stand-alone AI can do for free. We think they’re complementary. You can use AI in Adobe or bring it from the outside.
Creatives need Adobe tools even if they’re using a third-party AI service. We recently increased the position, which we’ve held for many years.
The author owns shares of Alphabet, Mastercard, Amazon and Adobe.
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