July 30, 2004 — The T Rowe Price New Horizons Fund (PRNHX) invests primarily in small companies, but its portfolio is far from petite.
John Laporte, who has managed the $5.4-billion fund for nearly 17 years, typically has stakes in 250-300 companies.
Because small stocks tend to be riskier and more volatile than large ones, Laporte has “felt that it’s prudent to spread the bets over a broader number of names, so that the fund won’t get hurt real badly if any one company falls short of expectations,” he said in a recent interview.
Covering a lot of ground hasn’t kept the fund from outrunning its rivals over the short and the long term. T. Rowe Price New Horizons was up 7.3% this year through June, versus 3.4% for both the average small-cap growth fund, and the Standard & Poor’s 500-stock index. For the ten years ended in June, Laporte’s fund returned 13.4% on average, compared to a gain of 9.5% for its peers, and 11.8% for the index.
Laporte hunts for companies that increase their bottom lines by at least 15% per year, preferably consistently, although he’s willing to accept cyclical growers, and others whose profits fluctuate. He also likes to see above-average returns on equity and invested capital, and solid free cash flow.
As for multiples, Laporte said he wants to buy “the fastest possible earnings growth” for the most reasonable price he can.” If he’s confident that a company will churn out strong profits steadily, he’s willing to pay “what might appear to be a high valuation at the outset.”
Laporte starts out trawling for companies with market caps of less than $1.5 billion, but won’t sell them if they grow to become large caps as long they keep putting up winning numbers.
For example, the he has owned Apollo Group`A` (APOL) since it went public in late 1994. The company, which provides higher education programs to working adults, now has a market value of $15.5 billion.
“A poor way to manage a portfolio is to set an arbitrary market capitalization number at which you will automatically sell a stock,” Laporte said. “It can cause a portfolio manager to sell some of their best companies way too early.”
Apollo, the fund’s No. 1 holding at the end of the second quarter, exemplifies what Laporte looks for in an investment. The company has been compounding earnings at a rate of better than 40% annually since its IPO, he said. In addition, it is the top player in the rapidly growing field of online education through its Apollo Grp-Univ Phoenix Online (UOPX) subsidiary, he said. That unit’s stock ranked fifth in the portfolio at mid-year.
Behind Apollo in the portfolio at that time was Schein (Henry) (HSIC), a distributor of medical and dental supplies. Laporte, who has owned the company for about 10 years, said it sports earnings growth of around 15%, compared to a growth rate of 6%-7% for its peers. He is also enthusiastic about Schein’s management team, which has helped boost profits partly through a string of good acquisitions, he said.
Rounding out the fund’s top five holdings at the end of the second quarter were two other health care companies: Omnicare, Inc (OCR), a nursing home operator; and DaVita Inc (DVA), which runs centers for kidney dialysis.
Shares of Omnicare sank on July 26 after the company reported weaker-than-expected second quarter earnings, and lowered its outlook for the full year. Laporte said he still likes the company, however, because its dominant position in its industry gives it a cost advantage over competitors, and enables it to fatten earnings faster than them.
DaVita’s attributes include annual earnings growth of about 15% and “excellent free cash generation,” according to Laporte. The company also stands to benefit as the U.S. population ages and requires the kind of services DaVita provides, he said.
The fund has gotten a boost in the last year from companies that serve the telecommunications industry, which Laporte has been buying over the last 12 months. These holdings accounted for 4.2% of the fund’s assets on June 30. Laporte owned shares of NII Holdings (NIHD), Nextel Partners`A` (NXTP) and Western Wireless`A` (WWCA).
While he won’t sell a company whose growth pushes it out of the small-cap camp, Laporte said he will unload those whose earnings appear to be slowing, or if he spots what looks like a better investment.
If a stock’s valuation seems to be getting excessive, Laporte will trim the position, but not necessarily eliminate it. “I think the mistake a lot of growth investors make is that they sell out of their best companies a little too early, just because they look too expensive,” he said. “So I try to take a longer term view of valuation and not sell my winners too soon.”
That part of Laporte’s investment philosophy is reflected in the fund’s turnover rate, which is considerably lower than that of similar funds. T. Rowe Price New Horizons turned its portfolio over at a 28.6% clip last year, compared to 142.5% for its peers.
Laporte said he typically keeps his cash position at 1%-2% (it was 0.4% at the end of June) and has had no difficulty finding investments lately. Although his fund is among the largest small-cap offerings in terms of assets, something investors should pay close attention to, he said its size doesn’t really present him “with any problems at all.”
Although small-cap stocks have performed well for the last five years, valuations in the group suggest that the rally has just about run out of steam, Laporte said. In the short run, the stocks will “continue to go up,” he said. “But they may not go up as much as large caps.”
Still, investing in small caps makes sense, Laporte noted, since studies have shown that over long periods of time they tend to do better than large caps.
Contact Robert F. Keane with questions or comments at [email protected].