|7 Small-Cap Stocks Poised for Big GainsThe Baron Discovery fund more than doubled the market last year. Here’s what it’s buying now.|
Aug. 1, 2017 6:53 a.m. ET
“You haven’t heard of them yet, but you will.” That’s how Randy Gwirtzman characterizes the stocks held by the small-cap growth-oriented Baron Discovery fund.
Gwirtzman and his co-manager, Laird Bieger, take advantage of the lack of research in the small-cap universe to exploit inefficiencies in the market and buy winners cheaply before they become well-known.
Doing their homework pays off. In a world in which passive investing is relentlessly gaining share as active management stumbles, the fund (ticker: BDFFX) hasn’t shared in the latter’s malaise: It’s No. 1 in its small-growth category year to date, as well as for the past three months and one year.
Over the past one and three years, it has handily outperformed both the Standard & Poor’s 500 and small-cap Russell 2000 indexes. In 2016, the fund gained 21.4%, more than double the returns of the S&P 500 and its peers—in a year when the Russell 2000 was up just 0.1%. The no-load fund charges annual expenses of 1.35%.
Today, Gwirtzman and Bieger see plenty of opportunity in the technology and health-care sectors. While their high-conviction portfolio may well benefit from policy changes in Washington relating to taxes, infrastructure, and mergers and acquisitions, the managers say that would just be icing on the cake. They spoke to Barrons.com about some of their favorite picks.
Barrons.com: Tech is a big overweight in the fund. Can you talk about some of your favorite names in the sector?
Gwirtzman: The largest position in the portfolio right now is Macom Technology Solutions Holdings MTSI 0.8422791081750619% MACOM Technology Solutions Holdings Inc. U.S.: Nasdaq USD61.06 0.51 0.8422791081750619% /Date(1501621200393-0500)/ Volume (Delayed 15m) : 827073 AFTER HOURS USD48.6 -12.46 -20.406157877497545% Volume (Delayed 15m) : 248191 P/E Ratio N/A Market Cap 3864785297.71576 Dividend Yield N/A Rev. per Employee 452015 More quote details and news » MTSI in Your Value Your Change Short position (MTSI), an analog semiconductor company. About half its revenues come from optical networking. We think that it has a differentiated product, particularly the laser on a chip that it produces. As data-center operators like Amazon.com AMZN 0.85140415882079% Amazon.com Inc. U.S.: Nasdaq USD996.19 8.41 0.85140415882079% /Date(1501621200397-0500)/ Volume (Delayed 15m) : 4381477 AFTER HOURS USD1003 6.80999999999994 0.6836045332717654% Volume (Delayed 15m) : 191099 P/E Ratio 252.84010152284264 Market Cap 474509775296.777 Dividend Yield N/A Rev. per Employee 439731 More quote details and news » AMZN in Your Value Your Change Short position (AMZN), Alphabet GOOGL 0.1121099947117927% Alphabet Inc. Cl A U.S.: Nasdaq USD946.56 1.06 0.1121099947117927% /Date(1501621200277-0500)/ Volume (Delayed 15m) : 1169367 AFTER HOURS USD951.5 5.34000000000003 0.5218897903989181% Volume (Delayed 15m) : 163089 P/E Ratio 34.29279444104296 Market Cap 649188358964.355 Dividend Yield N/A Rev. per Employee 1373290 More quote details and news » GOOGL in Your Value Your Change Short position (GOOGL), and Facebook FB 0.3604135893648449% Facebook Inc. Cl A U.S.: Nasdaq USD169.86 0.61 0.3604135893648449% /Date(1501621200262-0500)/ Volume (Delayed 15m) : 13877829 AFTER HOURS USD170.74 0.879999999999996 0.5180737077593313% Volume (Delayed 15m) : 507303 P/E Ratio 38.69248291571754 Market Cap 491219861572.266 Dividend Yield N/A Rev. per Employee 1945860 More quote details and news » FB in Your Value Your Change Short position (FB) start ramping up upgrades for higher-speed optical, which moves data faster, Macom is going to be incredibly well-positioned.
Baron Discovery fund
|Name: ||Randy Gwirtzman|
|Title: ||Portfolio manager|
|Education: ||B.A. in economics, University of Pennsylvania; J.D., Benjamin N. Cardozo School of Law; M.B.A., Columbia Business School|
|Hobbies: ||Skiing, golf|
That’s half of its business. The other half is radio-frequency chips, so it has a billion-dollar market it’s just getting ready to address in wireless-tower transmitters. That’s another unique space where it has intellectual property that has already been litigated. It is pretty well-situated to take a lot of market share there.
Bieger: Acxiom ACXM -0.07415647015202076% Acxiom Corp. U.S.: Nasdaq USD26.95 -0.02 -0.07415647015202076% /Date(1501621200225-0500)/ Volume (Delayed 15m) : 354436 AFTER HOURS USD26.95 % Volume (Delayed 15m) : 18948 P/E Ratio 539 Market Cap 2138046736.71913 Dividend Yield N/A Rev. per Employee 270014 More quote details and news » ACXM in Your Value Your Change Short position (ACXM) is a marketing data and analytic company. Broadly speaking, it’s going to help advertisers target their offline and digital-advertising campaigns in a more-efficient, higher-return-on-investment manner. It helps [advertisers] create audiences and target those audiences so you can get a higher ROI. It’s somewhat complex, with three divisions—what we describe a high-complexity-to-market-cap ratio. As a result, people don’t want to take the time to understand it or don’t think it is worth the time to understand. But when you peel back the onion, we believe one division—its connectivity division—has a business in it that is growing at 50% revenue year over year, and we don’t think that business is well understood by the market. We think that growth can continue, and the stock, which is today around $27, we value at $40 in two years.
Baron Discovery fund
|Name: ||Laird Bieger|
|Title: ||Portfolio manager|
|Education: ||B.A. in economics, Vanderbilt University; M.B.A, Columbia Business School|
|Hobbies: ||Backgammon |
Q: Health care is another big weighting for you, including Myriad Genetics MYGN -0.20601565718994644% Myriad Genetics Inc. U.S.: Nasdaq USD24.22 -0.05 -0.20601565718994644% /Date(1501621200341-0500)/ Volume (Delayed 15m) : 682821 AFTER HOURS USD24.22 % Volume (Delayed 15m) : 33561 P/E Ratio 53.82222222222222 Market Cap 1653223799.3399 Dividend Yield N/A Rev. per Employee 343336 More quote details and news » MYGN in Your Value Your Change Short position (MYGN), which some readers may already know.
Gwirtzman: Myriad Genetics is a hereditary genetic-testing company. Genes have a lot to say about what diseases you may be likely to get or what medicines might help cure them. Myriad’s base business was always about breast and ovarian cancer testing under the BRCA gene. Myriad had a patent on that gene, which the Supreme Court overturned in 2013. When that happened everybody thought that the business would go off a cliff, but it really didn’t, and Myriad has maintained 80% market share in this type of testing. The reason is that it has a high-quality test that has been clinically validated and has the ability to see many variances that other testing companies can’t. We think that business, while it is declining a little bit, will be more stable than the market thinks.
At the same time, Myriad made a great acquisition of another hereditary-testing company that tests for your ability to be compatible with depression and anti-anxiety drugs. There are nine million new people every year in the U.S. diagnosed with one of those conditions, and the company is running only tens of thousands of tests now. That business, we believe, has the ability to be as big or bigger than the base BRCA-testing business, and earnings could grow substantially over the next few years. The stock trades around $27 today, and we think this could be a multibagger over the next few years as people realize that earnings are going to grow at a pretty rapid pace.
Fund Facts (as of July 25, 2017)
|Baron Discovery ||(BDFFX)|
|Assets: ||$203.1 million|
|Expense Ratio: ||1.35%|
|Front Load: ||None|
|Annual Portfolio Turnover: ||91%|
|Source: Morningstar |
TherapeuticsMD TXMD -3.7168141592920354% TherapeuticsMD Inc. U.S.: NYSE American USD5.44 -0.21 -3.7168141592920354% /Date(1501635600001-0500)/ Volume (Delayed 15m) : 2312428 AFTER HOURS USD5.45 0.00999999999999979 0.18382352941176472% Volume (Delayed 15m) : 54771 P/E Ratio N/A Market Cap 1152034984.96056 Dividend Yield N/A Rev. per Employee 115798 More quote details and news » TXMD in Your Value Your Change Short position (TXMD), another holding, makes hormone-based drugs that are bioidentical—in other words, they have the exact same chemical composition as naturally occurring hormones. They are used to treat symptoms that are related to menopause. Therapeutics has a drug that was supposed to be approved in May, and we believe could be approved any day. It has been in discussion with the Food and Drug Administration for a condition called VVA, which has to do with intervaginal PH balance changes that could cause sexual and other discomfort in menopausal women. We think it is potentially a $1 billion to $2 billion or more market. The existing drugs on the market have higher doses of estrogen, and Therapeutics’ drug has the ability to come to market with a much cleaner label than the other companies have. Other companies have the black box, which indicates a potentially high risk of contracting cancer and other diseases with the drug.
The company’s second drug, which is due to be approved in early 2018, treats hot flashes caused by menopause. It is the first drug that will be on the market that, in one pill, will combine two different hormones, estrogen and progesterone, in bioidentical states. There is a multibillion-dollar market here. Currently, you either have to get two separate prescriptions or the drugs are made in compounding pharmacies. And new legislation requires compounding pharmacies to stop making these drugs if there is an FDA-approved drug on the market.
Q: As you mentioned, most of your companies are relatively unknown now. Any names that consumers might already interact with—even if they don’t know it?
Bieger: Red Rock Resorts RRR -0.04184100418410042% Red Rock Resorts Inc. Cl A U.S.: Nasdaq USD23.89 -0.01 -0.04184100418410042% /Date(1501621200175-0500)/ Volume (Delayed 15m) : 303522 AFTER HOURS USD23.89 % Volume (Delayed 15m) : 13924 P/E Ratio 27.147727272727273 Market Cap 2812391798.07199 Dividend Yield 1.6743407283382168% Rev. per Employee 106118 More quote details and news » RRR in Your Value Your Change Short position (RRR) owns and manages 22 casinos. It has casinos in Las Vegas that target local residents, instead of being on the Strip. Today, it is doing significant renovations at two of the casinos it owns, the Palms Casino and Palace Station. When you do these renovations, there is significant construction disruption and a short-term hit to profits. But we believe the investments that the company is making in these two properties should have good returns on investment, and as we look out to 2019, we believe that will come through in the profitability of the entire company. We think the stock, which is trading about $24 today, will be worth about $36 in two years, valuing it on 2019 Ebitda [earnings before interest, taxes, depreciation, and amortization].
Top 10 Holdings (as of June 30, 2017)
|Macom Technology Solutions||(MTSI)|
|General Communication ||(GNCMA)|
|Myriad Genetics ||(MYGN)|
|Liberty Expedia Holdings||(LEXEA)|
|Red Rock Resorts||(RRR)|
|Source: Morningstar |
Q: Let’s talk about the new additions to the portfolio.
Gwirtzman: Novanta NOVT 3.3875338753387534% Novanta Inc. U.S.: Nasdaq USD38.15 1.25 3.3875338753387534% /Date(1501621200227-0500)/ Volume (Delayed 15m) : 170920 AFTER HOURS USD38.15 % Volume (Delayed 15m) : 7398 P/E Ratio 24.612903225806452 Market Cap 1274895024.56665 Dividend Yield N/A Rev. per Employee 317901 More quote details and news » NOVT in Your Value Your Change Short position (NOVT) is an industrial company with half of its end markets in health care. It used to be called GSI Group; it had a different CEO and was focused basically on industrial lasers. We thought it was OK but not terrific. A couple of years ago, it hired a new CEO and sold off some of its less-interesting assets, and it has made a couple of acquisitions. It is all about precision laser components—effectively, the mirrors that direct the light used for measurement of the eye prior to eye surgery. Novanta’s lasers are also for industrial cutting applications where you need a lot of precision, and it has a lot of robotics-oriented precision movement components. It will sell components to Intuitive Surgical (ISRG) or other robotic-surgery companies. We believe it can double revenues and more than double cash flow over the next four years.
Bieger: General Communication GNCMA -0.3515350363252871% General Communication Inc. Cl A U.S.: Nasdaq USD42.52 -0.15 -0.3515350363252871% /Date(1501621200278-0500)/ Volume (Delayed 15m) : 92417 AFTER HOURS USD42.52 % Volume (Delayed 15m) : 3586 P/E Ratio N/A Market Cap 1537137121.39381 Dividend Yield N/A Rev. per Employee 402956 More quote details and news » GNCMA in Your Value Your Change Short position (GNCMA) is an Alaskan cable company that is being acquired by Liberty Ventures, part of the John Malone empire. When the deal closes—it expects approvals by the end of 2017—essentially what you will be left with is a company that is going to be renamed GCI Liberty. It will have about a third of its value in the General Communication Alaskan cable assets, and about two-thirds of its value will be in Charter Communications CHTR -1.1456712000204128% Charter Communications Inc. Cl A U.S.: Nasdaq USD387.42 -4.49 -1.1456712000204128% /Date(1501621200214-0500)/ Volume (Delayed 15m) : 2213811 AFTER HOURS USD387 -0.420000000000016 -0.10840947808579836% Volume (Delayed 15m) : 60194 P/E Ratio 112.29565217391304 Market Cap 101067320828.802 Dividend Yield N/A Rev. per Employee 446262 More quote details and news » CHTR in Your Value Your Change Short position stock (CHTR). It’s a way for us to own high-quality cable assets that in, say, three to five years, Charter will likely just take in-house. They’ll buy GCI Liberty and consolidate it, but for tax reasons they won’t be able to do that right away.