You'd think one of the oldest mutual funds would have figured out by now how to beat its benchmark on a consistent basis. And you'd be right. The $55.7 billion T. Rowe Price Growth Stock Fund (PRGFX) notches top results by holding leading growth stocks like Amazon.com (AMZN), Booking Holdings (BKNG), Alibaba Group Holdings (BABA), Microsoft (MSFT) and Google parent Alphabet (GOOGL).
Growth Stock Fund, which opened in April 1950, has beaten the S&P 500 Index for the one-year, three-year, five-year, 10-year, and 15-year annualized periods as of May 31 of this year, according to Morningstar.com. Since inception, the fund has posted an average annual return of 11.06% through May 31. That compares to an 11.3% return for the S&P 500. In the first five months of this year, the fund was up 8.54% vs. the S&P's 2.02%, and 6.73% for the large-cap growth mutual funds that are its direct rivals.
XJoe Fath, who's managed the fund since 2014, says holdings like Amazon, Booking, Alibaba, Microsoft and Alphabet share one key trait. "We're looking for innovative disruptors," Fath said. "It's a unique time. We're going through a powerful information revolution. Massive platform businesses are being built on top of powerful technology, and building a powerful network effect between users and platforms."
Fath seeks large-caps that can become megacaps because their growth is accelerating on a very big base of business.
"Google is a good example of that," Fath said, referring to Google's parent Alphabet. "They've been able to grow their top line 20% (annually) for a long period of time and that continues even as the company becomes much larger. The other big thing is they don't rest on the profit pool they've created. They continue to invest and break down barriers to new areas."
So far this year, Alphabet is up about 9% while Amazon is up about 46%. Gains by Alibaba, Booking and Microsoft range in between.
Mutual Funds Fath Competes With
The fund is large-cap focused, all $10 billion or more, mostly domestic with only 8% in foreign stocks as of March 31. Still, the fund has additional international exposure through its large-cap U.S. stocks, many of which have multinational operations.
To bring a stock into the fund, Fath needs to see double-digit growth in earnings and free cash flow year-over-year.
Fath assesses a company's total addressable market by asking: Is it in an area ripe for disruption? Who are the new entrants? He looks for stocks where the market under-appreciates the speed, pace and durability of a company's growth.
Online retailer Amazon is the fund's top holding because it's the "perfect example" of the innovative disruptor.
"It's going into many different directions at the same time and disrupting many different parts of the marketplace," Fath said.
The biggest area is e-commerce, driven by its Prime membership. The second is its cloud offering, Amazon Web Services. But it has other irons in the fire. The two biggest are advertising and hardware. Amazon is doing more advertising for third-party merchants that use Amazon as their storefront. It's also moving into home devices with the Alexa speaker system to compete with Google and Apple (AAPL).
Fath said Booking, the online travel agent that runs Booking.com, has a powerful business model. He said it's accumulated an inordinate amount of supply in Europe by adding a lot of branded and independent hotels, as well as alternative vacation homes and bed-and-breakfasts.
He said it's put pressure on aggregator travel sites such as Trivago by being more efficient with its marketing spend to drive people to its own site.
Another big holding is Alibaba, the Chinese e-commerce giant. Fath said it has probably one the best business models and is very cash-flow generative. It's at the epicenter of taking advantage of China's rising middle class, which can buy more and more goods and services.
Intuitive Surgical (ISRG) has seen its shares rise more than 60% over the past year. First-quarter earnings per share jumped 43% as revenue and profits topped expectations. The company makes the robotic da Vinci Surgical System. Its profitability is based on the classic razor-razor blade business model. It makes money on its robotic surgical system, then creates a recurring revenue stream with additional profits through sales of service contracts and disposable items like surgical blades and other instruments and accessories.
Fath also likes Nike (NKE), which has been out of favor as competitor Adidas (ADDYY) hustled its way to a resurgence in the U.S. He said Nike is beginning to ramp up its innovation engine, and will soon pump up a number of products, including its React sneaker line. Going forward, Fath said, "We feel very good about the fundamentals."
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