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From The No-Load Fund Investor, 4/14...
Tale of Two Styles
As measured by the Wilshire 5000 Index, the broad U.S. stock market was essentially unchanged in March. However, this result masked some divergent performances within the market, especially between ‘growth’ and ‘value.’ While the value funds we track produced an average gain of 1.7%, the average growth fund lost 1.8%. (While growth stocks tend to have higher-than-average earnings potential and valuations, value stocks tend to have lower valuations and a larger percentage of tangible assets compared to total assets.)
One reason for the performance dichotomy was due to reversals in some stocks in March that had been doing very well recently. From a sector or industry standpoint, the biggest example was the biotechnology industry, which is very oriented toward growth, and therefore well represented even in the diversified, growth oriented funds we use in the growth/value calculations. For instance, Fidelity Select Biotechnology (FBIOX), up 47.6% over the past 12 months, fell 12% in March.
This shows the danger of a pure momentum strategy. Sometimes, specific types of stocks or funds get into uptrends, and you can make a lot of money if you catch the wave and ride it for a while. However, they can reverse in a big way at any time, and then you don’t know if you should jump off or stick with them. One key to avoid being burned is deciding whether the positive momentum is based on long-term fundamentals, and if the stocks are priced appropriately in the market. If an industry, sector or type of stock seems to be going up forever without such solid underpinnings, it’s best to limit one’s exposure even at the risk of missing out if the uptrend continues.
Contrarian Growth Funds
The term ‘contrarian growth’ sounds like a misnomer. While ‘growth’ suggests a focus on stocks with above-average prospects for growth in sales and earnings, ‘contrarian’ implies a concentration on out-of-favor stocks with growth prospects that have hit upon tough times. One factor that can tie the two words together is time. It would be oxymoronic to find an out-of-favor company with great near-term growth prospects. However, the stock prices of plenty of companies with good products and services, even in growing industries, occasionally get pummeled for transitory reasons and become significantly undervalued as compared to their long-term growth prospects. Managers who buy these stocks during the down times and hold them for many years can produce outstanding long-term returns for their shareholders.
Best Buys includes one fund with an emphatic emphasis on contrarian growth: Fidelity Contrafund (FCNTX), which we include in each of our four Fidelity Funds models. During the three-year period ended Feb. 28, 2014, the fund produced an annualized gain of 15.3%, vs. 14.4% for the S&P 500 Index. Over the past 10 years, the fund has gained 10.2% annually, vs. 7.2% for the index.
Will Danoff has been the manager of Contrafund since 1990. Assisted by Fidelity’s global research team of equity analysts, he searches for larger companies that he believes are poised for durable multiyear earnings growth that is not reflected in their current valuations. He looks mainly for such companies with “best of breed” qualities, including those with strong competitive positions, high returns on invested capital, solid free-cash flow generation (essentially, real cash profits after funding day-to-day operations) and, of course, shareholder-friendly management teams. Though most of the fund’s stocks are large, Danoff looks for those led by visionary leaders with entrepreneurial impulses. He’s particularly interested in companies with innovative research and development, great products and brands, and strong and increasing market shares in growing industries.
For more analysis of Contrafund and other contrarian growth funds, see the April issue of The No-Load Fund Investor.
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