Institutional investors have been clearing out of stocks. They sold $42 billion worth in the five weeks ending Sept. 21.
That followed $51 billion in sales during the five weeks ending Sept. 7 — the biggest selling wave this year, says S&P Global Market Intelligence. Bank of America clients favored defensive names over cyclicals last week, another good contrarian signal telling us it is time be bullish and buy.
“This is a pretty good buying opportunity,” says David Baron of Baron Focused Growth Fund
“Even if there is a slowdown next year, a lot of stocks are pricing in pretty draconian earnings.”
No one knows for sure what the future will bring. But Baron is worth listening to, judging by his record. His fund beats its mid-cap growth category and Morningstar U.S. mid-cap broad growth index by 14 percentage points annualized over the past five years, according to Morningstar Direct. That’s big outperformance.
The catch is that it may be a stock pickers’ market.
“Not everything is going to work together,” says Baron.
Here are three ways to deal with this.
1. You can solve this problem by leaving the driving to someone else, such as Baron. His fund gets five stars from Morningstar, the highest, and it charges 1.3% in expenses.
2. You can take a peek inside his portfolio for stock ideas. “A slowdown does not change our thesis on our stocks. Our companies continue to innovate and continue to grow,” says Baron.
3. Better yet, take the “meal for a lifetime” approach and consider what you can learn from him about investing.
I tackled the last two approaches in a recent chat with Baron about his investment approach and his biggest — and most recently purchased — positions.
Here are five key lessons that might help you improve your returns, with stock examples for each.
1. Hold concentrated positions
This one is not for everyone. A lot of investing is about managing risk, and big positions increase your risk considerably because if they go bad, you lose a lot of money. But time and again, I notice that investors who outperform often do so via large position size. (Read this other column I wrote.) Talk to a financial adviser to see if this is right for you. But Baron has little doubt when it comes to his own fund. In a world where many managers cap their portfolio exposure to single names at 2% to 3%, at Baron’s fund, over 56% of the portfolio is in eight stocks. Each of those is a 4.5%-or-more position.
The biggest concentrated position, by far, is Tesla
at 20.4%. Baron Funds famously took a large position in Tesla before it went parabolic, and then stuck with it despite the vitriolic skepticism toward Tesla CEO Elon Musk.
Following the stock’s big move in 2020, the fund trimmed it a bit, but Baron is keeping a huge position.
“We see so much potential, we don’t want to sell,” says Baron. “Of all the companies I cover and [those] analysts come pitch to me, the company I feel the most confidence in is Tesla.”
Baron thinks the stock could still triple in less than a decade. What will get it there?
Tesla has created a strong brand with no marketing, and it has a 25% market share in electric cars, which are still in the very early stages of adoption. Only around 4% of vehicles are electric.
“People think we are going into a slowdown but demand for their cars has never been better,” he says.
Tesla delivered a million cars last year. It will deliver two million next year, and that’ll hit 20 million a year by the end of the decade, Baron predicts. Tesla produces high gross margins in the upper 20% range because cars that sell for around $50,000 cost around $36,000 to make. Baron thinks Tesla’s battery business could ultimately be as big as the car business.
The next four big concentrated positions are the privately held Space Exploration Technologies (also run by Musk), the insurer Arch Capital Group
and the real estate market analytics company CoStar Group
at 5% to 6% each. (Holdings are valid as of the end of June.)
2. Invest in growth
Baron pays attention to valuations, but the portfolio has a growth bias.
This brings big exposure to the gaming and lodging sector, which makes up 20% of the portfolio. Baron, who was once a gaming analyst at Jefferies Group, expects solid growth as people continue to want to break free of pandemic lockdown life.
“People realized in the pandemic that life is short, and they want to get out and do things,” he says.
Baron tilts his exposure to gaming and lodging companies that serve higher-income consumers.
Baron thinks that even in a recession, these companies should still generate cash flow above 2019 levels. Wealthier customers will cut back less on spending in any recession. These companies have gotten more efficient by better targeting their marketing and trimming some customer perks. Holdings here include Hyatt, Red Rock Resorts
MGM Resorts International
and Vail Resorts
Baron also cites Krispy Kreme
as a name with growth potential, as it continues to increase its presence in the marketplace, which Krispy Kreme calls “points of sale.” This includes things like prominent displays in convenience stores and supermarkets. Baron thinks Krispy Kreme could post 20% annual earnings growth, producing a double in the stock over the next three to four years.
3. Invest alongside founders
A lesser-known name from Baron’s holdings that fit the bill is Figs
The company sells scrubs, lab coats and related health-care sector apparel designed for comfort, style and durability. Figs stock has fallen sharply to under $10 from highs of around $50 shortly after its May 2021 initial public offering.
Baron likens Figs to Under Armour
the popular sports apparel company. “People love their product,” he says.
He thinks sales could double to $1 billion in three years. The company is run by co-founders Heather Hasson and Trina Spear. This is a new position for Baron as of the second quarter.
Another founder-run company in Baron’s portfolio is CoStar, which offers research and insights on commercial real estate trends and pricing. The company has a competitive advantage because it has the largest research team in the field, and it’s been in business for over 20 years. The company is expanding into residential real estate market analysis. This could help CoStar quadruple revenue or more over the next five years, says Baron. Founder Andrew Florance is the CEO.
4. Look for large market opportunities
Tesla is a good example, with its 25% share of the EV business that only makes up 4% of the overall vehicle market. So is another Musk company: Space Exploration Technologies.
SpaceX has two businesses, its Starlink internet service supported by a constellation of satellites, and its rocket launch business. Starlink has big potential because 3.5 billion people in the world are without internet access.
“This could be a trillion-dollar revenue business with extremely high margins,” says Baron.
Starlink recently signed on Royal Caribbean
and T-Mobile US
as customers. The rocket business has big growth potential because SpaceX can launch at one-tenth the cost of NASA.
Baron thinks SpaceX could be a 10-bagger over the next seven to 10 years. The problem for regular investors is that SpaceX is still private, and it may be years before it goes public because it doesn’t need cash, says Baron. Unless you are an accredited investor, it’s tough to get privately listed shares. For exposure to this one, owning Baron’s fund is one way to go.
5. Have some ballast
A risk with high-growth names is that their stocks can fall hard if growth stumbles a bit. Momentum investors in growth names are quick to sell.
To offset the risk of high-growth companies like Tesla and SpaceX, Baron likes to hold potentially safer names like Arch Capital Group in insurance and reinsurance. Arch Capital’s stock looks reasonably priced at 1.5 times its $31.37 book value. Second-quarter insurance sector net premiums grew 27.5%, year over year. Baron thinks the stock could double in four or five years.
Michael Brush is a columnist for MarketWatch. At the time of publication, he owned TSLA, DNUT, AMZN, META and RCL. Brush has suggested TSLA, RRR, MGM, DNUT, AMZN, META and RCL in his stock newsletter, Brush Up on Stocks. Follow him on Twitter @mbrushstocks.
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