By Carla Fried
While Morningstar’s (MORN) 2013 asset allocation fund manager of the year, FPA Crescent, is currently devoting significant assets to the stocks of challenged old-techs such as Microsoft (MSFT) and Oracle (ORCL) where it sees the problems already more than baked into the price, Morningstar’s Domestic Stock fund of the year is trafficking in newer generation tech-centric leaders on the growth side of the investing spectrum.
Among the top 10 holdings in the Morgan Stanley (MS) Focus Growth, run by lead manager Dennis Lynch and his team of co-managers cited by Morningstar as the top stock jocks in 2013, are Facebook (FB), Amazon (AMZN), Google (GOOG), Priceline (PCLN) and Salesforce (CRM). Facebook, which the team owned pre-IPO and has added to, accounted for 10% of assets based on portfolio holdings reported for the end of September (the latest available).
Value stocks they aren’t; the average PE ratio for the portfolio is above 25. And growth was rewarded last year. Morgan Stanley Focus gained nearly 50%, nearly 20 percentage points ahead of the market overall (the S&P 500). The fund’s 10-year annualized return of close to 10% is more than two percentage points better than the S&P 500. But as befits a growth-oriented approach, the feasts are often interrupted by stomach churning famine. In five of the past 10 calendar years the fund ranked in the top 10% of similar large-cap growth funds, and in three of the years it was in the bottom 10%.
Such stocks do well in an up market like 2013. This year's market isn't expected to match the huge returns we enjoyed last year. Thus, investors are encouraged to unleash some financial advisor tools on these stocks before committing.
Among the largest positions in the concentrated fund of about 30 stocks, Salesforce was the only stock the team bought more of in the third quarter -- adding 20% to its stake. That looks to be well timed as the stock has rocketed more than 60% from its third-quarter low.
But as impressive as revenue growth has been, we’re still talking about a company with negative EPS. Moreover, YCharts editor Jeff Bailey has pointed out that Salesforce is a poster child for non-GAAP reporting, and that’s not meant as a compliment.
Salesforce fits into the Morgan Stanley team’s rubric of an “emerging franchise” where it is less concerned about current traditional valuation issues and is more focused on what Lynch described to Morningstar as the “...endgame, or how big the company can be over a long period of time.” And by long he means a five to 10 year investment horizon. That explains how you can remain a true believer in a Salesforce, Amazon or Facebook, as well as LinkedIn (LNKD), which is also in the portfolio.
Another big addition in the third quarter was a more established franchise, Intuitive Surgical (ISRG); the team added 30% to its stake in the third quarter. Intuitive Surgical, which is a leading producer of robotic surgery systems, also landed in the Market Vectors Wide Moat ETF (MOAT) this quarter as the stock was slammed in 2013 by critical reports that its robotics may lead to higher patient complications, and that the robotic approach is more expensive than traditional procedures.
When the Wide Moat index was reconstituted in late December, Intuitive Surgical traded at a 9% discount to Morningstar’s fair value estimate of $400 a share. (Morningstar, an investor in YCharts, is the mastermind behind the methodology for the Wide Moat ETF).
But Intuitive Surgical stock has now rebounded to nearly 10% above Morningstar’s estimate of Fair Value. In early guidance for fourth quarter released in mid-January, Intuitive Surgical’s 5% revenue drop to $576 million was well above analyst expectations. The stock is sure to get booted from the ETF based on valuation in March if the current price trajectory holds.
The only other substantive addition as of the most recent filing was the fund’s position in Mead Johnson Nutrition (MJN). The infant formula manufacturer -- spun out of Bristol-Myers (BMY) five years ago -- derives more than two-thirds of its revenue from emerging markets in Asia and Latin America, considered growth markets for infant formula and nutrition supplements. Free cash flow has more than doubled over the past few years, while valuation -- for a growth stock -- remains downright reasonable.