- Fast-growing stocks performed well as the economy slowed but faded under the threat of higher rates.
- However, a mind behind a top growth mutual fund said investors shouldn’t abandon the trade yet.
- Here’s how to successfully invest in growth stocks and examples of places to target now.
Despite a recent setback, growth stocks remain popular as concerns about the US economy persist.
The Nasdaq Composite index, which is heavily weighted toward technology, is up nearly 30% in 2023, its best run since the liquidity-fueled rally of 2020. It’s also a significant improvement over last year’s disastrous 33% drop.
A favorable environment for fast-growing companies has propelled the USAA Victory Growth Fund (USAAX), which has been in operation since 1971, to its best year of relative performance since 2014. According to Morningstar, the fund’s 34.9% return over the last year places it in the top 5% of its category.
“Investors are really craving higher-growth-oriented companies because growth is becoming more scarce in the market,” Lance Humphrey, portfolio manager at Victory Capital Management who oversees the fund’s investing strategy, told Insider in a recent interview.
Humphrey went on to say, “Investors have been willing to pay a healthy premium for companies that have the ability to not only grow today but grow into the future.”
Look for these characteristics in high-growth stocks.
Instead of picking stocks for the USAA Victory Growth Fund, Humphrey assists in risk management by selecting and supervising managers who make investment decisions. Humphrey discussed the fund’s strategy and the best opportunities for growth he sees right now.
Investors who want to replicate the fund’s success should first be patient and hold stocks for the long term, according to Humphrey. Growth stocks may generate earnings quickly, but that doesn’t mean investors should sell them right away — even after setbacks such as a poor quarter.
“You’ll hear a lot of managers say, ‘We have a long-term focus,'” says Humphrey. “It’s another thing to look at the holdings and say, ‘These holdings have been in here for many years.'”
Humphrey’s growth fund managers, he claims, think like owners rather than traders. Humphrey, on the other hand, explained that he rebalances the portfolio on occasion by trimming stocks to minimize risk, which explains why the fund has a deceptively high stock turnover rate of 62%.
According to Humphrey, every stock in the 52-year-old growth fund has tailwinds such as sustainable earnings growth and defendable competitive advantages.
“What you’ll see in this portfolio are companies that not only have grown in the past, but we believe will be able to grow in the future because of some sort of sustainability around their business model,” he said. “So, companies that have a very specific competitive advantage that it makes it hard for an incumbent or a competitor to come in and overtake.”
Companies that fit this mold include social media behemoths, which have unrivaled network effects due to their massive user bases, according to Humphrey. While he did not mention specific stocks, one of the fund’s largest holdings is Facebook parent Meta.
According to Humphrey, attractive investments have high returns on capital and the ability to return that capital to shareholders through stock buybacks and dividends.
Some growth managers treat valuation as an afterthought, but not Humphrey’s team. According to the portfolio manager, the group considers how much a stock could rise relative to its bear scenario and only invests in those that appear to have at least twice as much upside as downside, as determined by intrinsic value measurements such as discounted cash flow (DCF) models.
Despite the fact that Humphrey’s managers take a bottom-up stock-picking approach, there are some notable trends within the fund. The majority of the fund’s holdings are large, US-based companies in sectors such as technology, communication services, and consumer discretionary, though Humphrey said he works hard to avoid overexposure to any one group or company.
How can a shaky economy generate growth?
For the first seven months of 2023, growth stocks led the broader market higher as investors braced for slower economic growth and lower interest rates.
The outstanding rally came to an end as the second half of that thesis came under increased scrutiny. Stock valuations have fallen as a result of the Federal Reserve’s announcement last month that it intends to keep interest rates higher until 2024. Tighter financial conditions reduce earnings multiples and, after much speculation, may cause the US economy to contract.
Despite the market’s uncertainty, Humphrey and his team remain unfazed. Higher interest rates may be a drag, but companies that continue to grow in a slowing economy will stand out.
“This fund, in and of itself, is going to be essentially fully invested in growth stocks — regardless of the macro environment,” Humphrey said in a statement. “That being said, what’s happening in the macro environment may create different opportunities at the bottom-up level.”
Instead of hiding in cash, Humphrey believes that investing in the media, communications, and biotechnology industries is a good idea right now. In contrast, he is avoiding technology hardware stocks, believing that the sector will be dragged down if a recession occurs.
Along with Meta Platforms (META), the top holdings of the USAA Victory Growth Fund are streaming media titan Netflix (NFLX) and communications conglomerate Alphabet (GOOGL). After being shelled in early 2022 as their valuations were compressed, those stocks have taken off in the last year.
Because of the industry’s boom-or-bust nature, biotech firms carry risk, but Humphrey said one of his managers is adept at sifting through the winners and losers. Vertex Pharmaceuticals (VRTX) is one of the fund’s top holdings, up 30% since mid-March, thanks in large part to optimism about the approval prospects for its promising non-opioid pain treatment drug.