When it comes to mutual fund management, Bob Smith’s approach could easily be summed up as “Slow and steady wins the race.” Disdainful of those funds that frantically chase after gains, Smith has steadily steered the T. Rowe Price Growth Stock Fund, relying on solid research, a highly diversified portfolio, and a deep understanding of what’s taking place in the market to deliver consistent returns to shareholders.
Last year, the fund was up 31.23%, outperforming the S&P 500 Index, which returned 28.7%. For the one-year period ended March 31, 2004, its return was 35.41%, while its style peers returned 31.23%, the S&P 500/BARRA Growth Index 26.74%, and the S&P 500 Composite Index 35.11%. Currently, holdings in large companies in the consumer discretionary, financial, and information technology sectors (pretty evenly split) make up about 60% of the fund’s assets, while healthcare accounts for another 14%.
The key to the fund’s performance may lie in the ability of Smith and his research team to identify companies with consistent growth and stable earnings streams regardless of overall economic conditions.
The financial ratings community seems to agree that Smith is on the right track. S&P recently upgraded the fund from three stars to five, matching its Morningstar rating, while Lipper gives it high marks for overall returns and expenses.
How would you describe your investment philosophy? It starts with the underlying assumption we have, which is that, over time, stocks have cash flow and earnings growth, and the stock’s price will go up. That’s a pretty basic assumption.
What we then try to do is find those companies that have double-digit growth in earnings and cash flow over a three- or five-year base–in the 12% to 15% range. We sometimes find companies that are higher. United Healthcare, for instance, over time has been better than 15%, but a lot of our companies are in the 12% to 15% range. And we think that if we can pay a fair price, a fair price being somewhere near market multiples, then even if the multiples remain flat you can compound your earnings and cash flow. That’s pretty much what we’re trying to do.
We have a pretty deep research staff whose goal is to find those companies. On average, the market tends to expect earnings to compound at a 12% to 13% rate, though on average they compound at about 7%. So the [market] analysts are wrong.
I see it as an absolute return type of investing. If we find companies that can [grow that way], and pay a reasonable price on an absolute basis, we should offer pretty good returns.
How is what you are doing different than a fund that’s based on an index like the S&P 500? The S&P, if you think about it, represents the average company. So if you’re buying the S&P on average, you would think that the S&P should put your gross earnings at 7%, and that over time it should be that type of return plus whatever dividends you have.
What we’re doing is trying to find companies that have been 300 to 500 basis points higher in growth over time.
How big is the fund and how big would you like to see it? It’s about $6.5 billion now. We hope it gets to $50 billion.
Is this a team-managed fund? We have a lot of analysts, but I’m the one that makes all the investment decisions.
How would you describe your role with the fund? My job is to find ideas, to find companies that can grow earnings at a double-digit rate.
What makes this fund work? I think the first thing is that we have a pretty good research staff. We’ve done a reasonable job of actually finding companies that can grow. Second, we take a longer-term approach. I think one of the issues that has plagued a lot of other funds is that they tend to react. They tend to be like stock investors where they chase (the market) and buy things that have already gone up. We try to take a longer-term approach. Rather than trade stocks, we try to buy companies that can grow over time.
Does the size of the fund restrict you in any way? It is a large-cap growth fund, so it is restricted somewhat by the nature of what it looks at. At the very lower end of the market-cap range it can, at times, be restrictive, but only slightly. With the majority of our companies, it really doesn’t restrict us at all. In some ways it helps us. It helps us to be longer-term investors. So while the volume might be restrictive at the lower end of the market cap, I think it helps us to stick to our philosophy of long-term investing, because when you’ve got a big ship you can’t turn it in a few minutes.
Can you talk about your screening process? We’re looking at companies with over $4 billion in market capital. We’re trying to find companies that we think can have 10% plus-inflation-type growth, so [we're back to that] 12% to 13% growth. On occasion we’ll find something that’s a little less, but we’re looking for those companies that the research shows can have that growth.
Then we look into value, and the nature of what’s happening in terms of market share. We try to find companies that are taking market share, that have cultures that are enduring and prosperous, that are trying to improve, and that have very good information systems and capital allocation systems.
Since the end of the year you’ve made some shifts in your largest holdings, adding Dell, GE, and WellPoint Health into your top 10 while moving away from First Data, Cisco, and Comcast. What caused those moves? In terms of Wellpoint going up, it was a combination of the fact that I really like the Wellpoint/Anthem combination and that the stock had done well.
General Electric is a stock that we haven’t really owned that long. We had some for the long term, but it was a pretty significant underweight. I think that all GE’s issues are behind it by the second quarter of this year, and that after that you’re going to have a solid double-digit growth for the next five. I’ve become much more bullish on GE and I’ve been buying, but it’s not really going to show up in the numbers until ’05. So gradually we’ve been adding to General Electric. I think it will be a very good catch from the $30 to $31 level [as of April 19, GE was trading at $31.07]. It’s going to be a very good stock over the next three years.