The 2018 stock market has not been for the faint of heart, having already notched all-time highs and the biggest correction in two years. But some stock mutual funds have found ways to both post gains and surpass major indexes, often with investment strategies that include such stock market leaders as Amazon (AMZN), Adobe (ADBE), Netflix (NFLX) and Salesforce.com (CRM).
For the year through March 7, Fidelity Investments’ Will Danoff and John Roth have deftly ridden such stocks to a nice 6.22% gain in the fund they manage; $28.5 billion Fidelity Advisor New Insights Fund (FNIAX). That compares with the S&P 500’s 2.35%. The legendary Danoff is best known for managing the $129.6 billion Fidelity Contrafund (FCNTX) since 1990, and with which he’s outperformed every other stock fund with $100 billion or more in assets in the past 15 years.
Many of their top holdings are riding a megatrend — people spending more time on the internet — that they see driving earnings growth and price appreciation for years to come.
A key to the winning investment strategies they’ve used since New Insights’ inception in 2003 is change. “We always look for change,” Danoff told IBD, “and change is an opportunity: when there’s a new management team, a new product, a spinout or a big acquisition.”
While New Insights is solidly in the large-cap growth camp, Roth brings in expertise in midcap stocks and a slight value tilt, which adds a level of flexibility to the managers’ investment process as they navigate 2018 stock market trends.
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In a wide-ranging Q&A, Danoff and Roth share how their flexible investment strategies allow them to uncover opportunities even as the bull market ages and many growth stocks get pricey. They also discuss their major holdings, including why they’re bullish on Amazon, Netflix and Adobe.
Investment Strategies 2018
IBD: What is the strategy of your fund?
Will Danoff: Fidelity Advisor New Insights is a capital appreciation fund with a growth bias. Both John and I believe that stocks over time follow the underlying earnings per share of the companies. I’ve joked in the past: You get two fund managers for the price of one. We created a sleeve structure two years ago: Will is running 60% of the fund, John is running 40% of the fund. John has a more value orientation, I have a more growth orientation.
IBD: What is the main trend in the market today and how are you integrating it in the fund?
Danoff: I’m looking for the best stocks in the market and companies that have a sustainable competitive advantage but are growing in this environment, gaining market share, are able to leverage technology and find certain trends like Cloud or SaaS (Software as a Service) or just more and more people and more and more companies spending more time on the internet. That’s probably the megatrend that we’re all living in.
Growth Stocks Vs. Value Stocks
John Roth: I’ve spent half my time at Fidelity as a value-ish analyst and half as a growth analyst. I prefer to buy growth stocks — I think they’re more fun, more interesting. But I think you can also make money in turnarounds and other things that the market has left by the wayside.
Nine years into a bull market, I think there’s some valuation concerns on the growth side, so that’s taken some of my growth money out, but I still have a growth bias. I think the key is to be versatile and really take advantage of the opportunities the market gives you.
Danoff: We’re flexible and we’ll go anywhere, so I really think that helps the fund. There aren’t many constraints on what we can do. And John has been really good at anticipating which out-of-favor groups might come back into favor. And by looking for out-of-favor groups, that forces you to look at your existing names and say “Wow, maybe all the good news has been discounted here.”
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IBD: Speaking of which, could you give a few examples of trades in the past 12 months?
Danoff: We were up 28% last year and tech helped a lot. Amazon was a nice overweight, Activision Blizzard (ATVI), PayPal (PYPL), Facebook (FB), Adobe — these were larger technology companies that grew very nicely.
We always look for change and change is an opportunity: when there’s a new management team, a new product, a spinout or a big acquisition. When something’s happening, Fidelity can hopefully move quickly.
Last year was about avoiding some of the defensive names, General Electric (GE) obviously struggled with their earnings. … We were underweight in a big way.
Where To Find Good Stocks Like Facebook
IBD: Your fund profile talks about companies that are undervalued by the public. But obviously the public is focusing on the big tech names, so how are they undervalued or what is the additional value that you’re seeing in them?
Danoff: John and I are looking for misperceptions by the public. If we think Facebook can sustain 30% growth for longer than people think, or we see Mark Zuckerberg’s genius ultimately being applied to Instagram, WhatsApp, Facebook messenger (and) video. … We’re not seeing anything that other people may not see, but we think the good news will last longer. I think I am more bullish on Facebook than the consensus and I own a lot of it.
Roth: A lot of times these big names are right in front of you and it doesn’t mean they’re not going to be great stocks. Apple (AAPL) has been the poster child. Back in 2007, people got excited about the potential for the company to have $6 billion in revenue, and no one thought they’d go to $250 billion. And it unfolded slowly over the years right in front of you.
IBD: What are your thoughts on the fact that we’re late in the economic cycle and valuations are high?
Danoff: Yes, we’ve had a long run since the bottom of the spring of 2009, earnings have more than doubled, stocks have more than tripled. The crisis of 2008-2009 I think was felt more deeply than people realize. … (The economic impact) was quite drastic.
There was this massive footrace to put on the brakes — cutting costs, cutting capital spending. Sort of the whole world froze. I think Apple and Google were two of the only companies I’m aware of that grew earnings in the first two quarters of 2009.
My point is, the starting point was quite drastic. And so even though we’ve had this long economic expansion, I don’t feel like people are high-fiving themselves. Up until very recently, most companies were managing the costs conservatively and controlling their capital spending.
2018 Stock Market Trends: International Stocks
The other observation I have is the world is much more global and U.S. companies are now able to sell their products all over the world. The big companies in the S&P 500 are now much less capital intensive; they’re high margin, they’re high growth and they’re highly cash generative. Yes, I think the market is expensive, but the market is not what it used to be. The quality of the companies is higher and estimates are going up.
IBD: Would you look more outside of the U.S. to find good stocks?
Roth: Our philosophy is turn over as many rocks as you can. The more you turn over, the higher the probability to find something good. If we find that the U.S. has less opportunities, then maybe we’ll look harder in Europe. Europe has been slow to recover and there are some interesting names there. And the same would be true in Asia. You might see more names in the fund because we’re trying to find new ideas.
Danoff: The global research effort helps us so much. The global economy is much more integrated. We can talk to Asian tech companies who are part of the supply chain, or Samsung, which is a supplier and a competitor to so many of the big tech companies, and Taiwan Semiconductor (TSM). It’s hugely helpful to understand where we are in the cycle in that particular industry.
The trends we’re seeing overseas are often similar, sometimes ahead of the trends that we see in the U.S., sometimes behind. But in terms of the big global companies, often the Nestles (NSRGY) and Unilevers (UN) are more defensive, and right now defensive is out of favor. So we’re trying to pay attention to out-of-favor, but right now these stocks are not leading the market. This is the tension and the balance we have to find.
IBD: The market had a short correction recently. How do you react in this kind of environment?
Stock Market Volatility And Investment Strategies
Roth: We went through a very long period of no volatility and to the extent we see more volatility in the future as the economy heats up and the Fed gets more aggressive, it just means that we have to tighten our game up and look for dislocations every day. We’ve had some really big swings in the market where you could open up and then all of a sudden be down a fair amount, and so on an individual stock basis we’re looking for bargains on the names that we really like. We do have some cash in the fund and we can be opportunistic. So a little bit of volatility is not a bad thing at all.
IBD: Do you sell anything in those times?
Danoff: You have to stay flexible and when fundamentals change, we all have stories when a top 10 position discloses some bad news and the stock is down and you start saying, “Oh my God, one of my big positions is under pressure.” If there’s competition from Amazon, or there’s regulatory changes, or there’s unexpected margin pressure, you can’t stand still in this business.
When the whole market sells off, John and I are looking for higher-quality companies that we can upgrade to.
2018 Stock Market Trends: Inflation
IBD: Considering the current increasing inflationary pressures, do you see any sector rotation or areas that may pop up that would be more advantageous for investors in 2018?
Roth: We are seeing wage inflation. Everyone from Walmart (WMT) to most big companies have started to pay their employees more. These bonuses that are coming as a result of the tax cut will have the same effect.
Who benefits? It’s probably the financials to some extent, probably the energy companies, materials, gold. We have exposure to all of that, and we can easily shift if it looks like it’s going to become more prevalent.
Stock Outlook For Netflix, Adobe And Amazon
IBD: What is your outlook for some of the big names in your fund?
Danoff: Good news is good news. In an expansionary environment, Netflix is crushing it overseas. They’re adding 5 million subs overseas a quarter and a couple million subs in the U.S. They have some pricing power, the service is outstanding, it’s a subscription model offering great value for roughly $10-$11 a month. The average subscriber is spending 10 hours a week watching their content. Margins are going up and I am quite positive.
Adobe has made a shift from licensed to Software-as-a-Service to the recurring revenue model. More and more people are spending more and more time on the web, so companies and individuals purchase Adobe software more frequently. Revenues are growing more than 20%, margins are going up and the company is generating a huge amount of free cash flow, so the outlook is very bright for Adobe. Could it sell off because it’s expensive? Yes, both Adobe and Netflix could see multiples compression near-term, but I think over time both companies are very well positioned to grow, looking out three to five years.
Amazon — wouldn’t you want to partner with the richest man in the world, Jeff Bezos? A week does not go by where somebody doesn’t tell me “I love Amazon.” AWS, which is their cloud-computing business — they started before anybody else realized that could be a business — it’s now I think an $18 billion business, growing roughly 40% a year; it’s nicely profitable. In e-commerce, he’s pushing hard into India, into food, in apparel — he’s gaining market share. He’s got a long way to go. Maybe I’d like him to show a little more profit because I think stocks follow earnings over time, but I’m confident that everything Amazon is investing in is ultimately going to generate a very strong return, and if that’s the case, then profits will come over time.
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