Small-cap stocks have underperformed large-cap stocks for the past 10 years. So now might be a good time to look for opportunities in the former category.
One possibility is Needham Small Cap Growth Fund (NESGX) . The fund has $147 million in assets, according to Morningstar.
Through March 31, it produced annualized returns of 4% over the past 12 months, negative 8% over the past three years and positive 14% over the past five years, according to Needham.
That performance beat the Russell 2000 Growth index of small-cap stocks for the five-year period and trailed it for one and three years.
The Street spoke with Ward Sexton, a manager of the Needham fund, about his views on investing. Like most growth-stock managers, he looks for high-quality companies. But he also looks for stocks underappreciated or unfollowed by other investors.
“Overall, we have a contrarian flavor,” Sexton explained. Here’s what he had to say, including several stock picks.
TheStreet/Needham Funds
A contrarian small-cap growth stock strategy
TheStreet.com: What’s your investment philosophy?
Sexton: We look for traditional quality growth companies – ones with great management and a durable business. We differentiate ourselves by finding three areas of inefficiencies more prevalent in small-cap stocks.
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First, we look for companies that are growing faster and/or are more durable than what the market embeds in their price.
Second, we look for companies with a fallen quality of growth. Something went wrong, but the long-term growth profile hasn’t changed. The market may have overreacted to a transitory event. We’re taking the other side [from the consensus]. Overall, we have a contrarian flavor.
Third, we look for companies with undiscovered quality growth. This is something more common in small caps. Something fundamental has changed, or the business is materially different than people have known.
Or the company’s doing fine, but it’s not covered by analysts. You can find these companies across the small-cap spectrum, but more in the microcap area [stocks with market capitalizations of $50 million to $300 million].
These companies are often more willing to meet with us than large-cap companies are.
There are a lot of opportunities to find misunderstood or lesser-known names that will grow to become large-caps.
TheStreet.com: Are there any industries and market themes you particularly like?
Sexton: We’re more stock-specific. But one theme is energy transition – electrification of cars and everything else. There’s a lot of government stimulus for this. And artificial intelligence has introduced a whole new power pull.
Money manager highlights three small-cap growth stock picks
TheStreet.com: Can you talk about three of your favorite stocks?
Sexton:
No. 1. Establishment Labs (ESTA) .
They make breast augmentation implants. They’re growing market share the fastest globally.
Regulators have approved it in China, and they’re awaiting approval in the U.S. We expect that will happen just like the approvals they’ve received in other developed countries.
We all have heard about the medical risks of breast implants, but Establishment Labs has the best safety profile of any implant. They have a new product in Europe that involves a minimally invasive procedure – outpatient.
That opens the market to a whole new group of people. The stock has underperformed and is underappreciated.
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No. 2. Garrett Motion (GTX) .
They design turbochargers for gasoline and diesel engines. The turbochargers increase fuel efficiency.
People are worried about the future of internal combustion engines. All suppliers to internal combustion engines trade at depressed multiples.
But Garrett is heavily invested in electric vehicle technology. In addition, the company supplies hybrid engines, and we’re seeing a shift in demand to hybrids from purely electric vehicles. So, the company should participate whether EVs or hybrids win.
The stock is heavily discounted and generates more cash flow than competitors. It’s a growth stock priced like a value stock.
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No. 3. BioLife Solutions (BLFS) .
They sell products [bio-preservation tools and services] used to manufacture cell-therapy drugs. The cell therapy market is growing rapidly, 20% annually, because of the drugs’ [effectiveness.]
Hundreds of cell-therapy drugs are in the pipeline. And BioLife products are a candidate to be used in manufacturing when drugs are approved by the FDA.
The media [materials] they sell to process cells are written into the FDA applications filed by drugmakers, so, the drugmakers are locked into using their products.
BioLife has a 75% market share, and we expect the market to keep growing over 20% a year. The stock is underpriced for that.
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