When shopping for stocks, Sandy Sanders looks for stocks with price tags offering 30% off. "We look to buy stocks selling at 70 cents on the dollar or less," said Sanders, manager of John Hancock Fundamental All Cap Core Fund (JFCIX) and one of the best mutual funds.
But Sanders isn't buying junky companies that are cheap for a reason. Instead, he opportunistically loads up on quality companies that have a sustainable competitive advantage, but whose stock price has suffered a short-term haircut. His all-cap fund gives him the flexibility and freedom to shop for stocks in every aisle of Wall Street's stock supermarket. He can buy large companies like Amazon.com. Or he can pick up small companies like First Hawaiian Bank. He can also put growth stocks like Nvidia and value stocks like Cheniere Energy on his shopping list.
"It's our best idea portfolio," said Sanders. The fund typically holds about 50 stocks, with the top 10 holdings accounting for roughly half of the fund's weighting.
The buy 'em-when-they're-cheap strategy has paid off. The $541 million fund is a 2024 IBD Best Mutual Funds Award winner. That means John Hancock Fundamental All Cap Core Fund has topped the S&P 500 in the past one-, three-, five- and 10-year time periods ending Dec. 31, 2023. The fund has posted a total return of 18.12% this year through the end of August, trailing the market benchmark's 19.41% advance.
A Best Mutual Fund's Seven Step Process
Sanders, who heads a team of 11 investment professionals, uses a seven-step research process. It takes about a month to find stocks that are ahead of their peers and are likely to maintain their lead. The strategy allows him to pounce when a stock that makes the cut falls 30% below its base case valuation.
The first step validates whether a company has a competitive advantage. "Making sure it's a good business that's going to be here for a long time," said Sanders.
Step two entails making sure a company is in a good industry with a history of robust returns on invested capital and good growth. "The key is not buying a business that has no competitive advantage and is low quality," said Sanders. Using that filter, the fund avoids pockets of the market such as airlines, automobiles, telecom, utilities, and metal and mining companies, he says.
The third filter seeks companies with growth drivers. "What's going to propel a company's growth over time," Sanders said.
Step four focuses on a financial statement analysis. Balance sheets must be strong. Cash flows must be plentiful. And debt ratios must be low.
The fifth filter assesses the management team. Sanders uses in-person meetings with top executives to confirm that the company's moat is sound and its growth runway is long.
Step six, which Sanders calls "the bread-and-butter" of the fund's investment process, launches an in-depth valuation analysis of each company on the watchlist. The portfolio team ranks each stock with best case, base case, bear case and a worst-case valuation scenarios.
The final step assesses risks.
Best Mutual Fund's Search For Top Stocks
When the seven-step analysis is complete and a stock meets all the criteria, it's added to the fund's watchlist. The watchlist typically totals some 250 stocks. Each morning Sanders and his team look for stocks on the list to see if they are down enough in price to present a buying opportunity. "We put 11 sets of eyes on the analysis," said Sanders. "We rank every stock by cents on the dollar (discount), and that allows us to have a real-time active list of names that have been vetted."
Sanders doesn't push the buy button prematurely, though. "We will wait for the right price to pay, which is 70% of our base case value."
A big advantage of running an all-cap fund is that investments in small stocks that grow into megacap names don't have to be sold due to growth. Fund rules don't force portfolio managers to sell stocks once they grow beyond a certain market cap. Sanders recalls buying Nvidia back in 2018 (when the stock ended the year at $3.31) and being able to hang on to take full advantage of its huge run-up in recent years. Nvidia, which makes powerful chips for artificial intelligence applications, now has a market value of nearly $3 trillion.
"We can hold on to our winners," said Sanders. "The challenge of being a small-cap or midcap fund manager is that you have to sell your best ideas to a large-cap manager."
Going Beyond The Box
And unlike most mutual funds with a specific investment mandate, John Hancock Fundamental All Cap Core Fund is not stuck in a one-style box. It can invest anywhere it wants.
So, what stocks does Sanders like now?
He's bullish on consumer discretionary stocks. The reason: he says the U.S. consumer is in decent shape. Americans have strong balance sheets, the job market remains strong, and wages are on the rise. The upshot: "Consumers have extra money in their pockets," said Sanders. And with the Federal Reserve set to lower interest rates for the first time since hiking its key borrowing rate to 5.25% to 5.5% in July 2023, consumers will benefit from the stimulative effect of lower borrowing costs.
That's a big reason why online retailer Amazon.com, a member of the Magnificent Seven, is the fund's top holding. Sanders thinks Amazon offers good value after its second-quarter revenue of $148 billion narrowly missed forecasts and the company issued tepid guidance for the current quarter. "Amazon represents great value here, and looks pretty sharply undervalued based on our process," said Sanders. Amazon stock finished August at $178.50, down 11% from its July 8 high of $201.20.
Sanders also is bullish on homebuilder Lennar. The second-largest U.S. homebuilder, he says, is benefiting from the housing shortage across the nation. "They are a beneficiary of a supply-starved housing market," said Sanders. He says Lennar's balance sheet is strong with $6 billion of cash and no debt. Lennar is also sharing more of its profits with shareholders. The homebuilder raised its dividend earlier this year by 33% to $2 per share, up from $1.50.
Picking Up Financials
Financials are in the sweet spot, too, as the Fed gets set to embark on a rate-cutting cycle, says Sanders. "The capital market cycle is likely to restart this year and extend into 2025 as borrowing costs come down. That means more companies will opt to go public, more debt deals will come to market, and more banking deals will get done."
Sanders likes private equity firm KKR because it now is in a better position to bring the private companies it owns back to public markets via IPOs. "KKR will generate returns on the investments it has made and benefit from rising capital markets," said Sanders. Similarly, large investment banks like Morgan Stanley and Goldman Sachs, two fund holdings, are well positioned to profit when the capital market cycle picks back up. Both investment banks trade at below-market price-earnings ratios.
On the small-cap side, Sanders is bullish on First Hawaiian, a bank in Hawaii that he says "dominates the niche market" there. First Hawaiian and Bank of Hawaii, he says, control about 60% of market share in Hawaii. A strong position gives First Hawaiian pricing power on its financial products, which boosts its return on equity.
When buying small caps, Sanders wants to know that a company has some sort of durable competitive advantage.
"We're always looking for small companies that dominate a niche," said Sanders. "We want to make sure there's something special about the business that makes it sustainable."
Sticking With Nvidia
Sanders still likes Nvidia, too. He says the chipmaker is still taking market in the data center space. Nvidia's chips are faster and can do multiple calculations at the same time, making them a must-have product for countless companies. Nvidia is also a leader in AI chips, an industry still in its early days, which bodes well for Nvidia.
As for the stock market overall, given the strength of the U.S. consumer, a resilient economy, and the Fed's coming rate cuts, "the setup is actually quite favorable" for the stock market," said Sanders.
In his mind, the biggest risk out there is the U.S.' strained relationship with economic power and big trading partner China. "Making sure these two countries are getting along is important," said Sanders.
