Small, rapidly growing companies are risky investments, and many people who lost money when the Internet bubble burst are avoiding risk. That is a mistake, says Matthew Ziehl, lead manager of the US$297 million Salomon Brothers Small Cap Growth fund.
"The outlook for small growth stocks is good, given that valuations are attractive," Ziehl said from his Manhattan office. "These stocks have historically outperformed as the economy moves toward a recovery."
The fund returned 22.9 percent, a year, on average, for the three years through July 31, after adjusting for its 5.75 percent maximum sales load. This compares with a 10.7 percent load-adjusted return for its small growth group and 3.9 percent for the Standard & Poor's 500-stock index, according to Morningstar Inc. It fell 13.9 percent, load-adjusted, in the 12 months through July, versus a 16.9 percent load-adjusted loss for its group and a 14.3 percent drop in the S&P 500, Morningstar said.
PHOTO: NY TIMES
Ziehl, 34, describes himself as a fundamental growth investor. "We're not in the momentum, or technical growth camp," he said. "Over the long term, the fundamentals of the company and the industry are what drive returns in stocks."
Ziehl uses no computer screens to select the roughly 100 stocks in the final portfolio from among 1,500, mostly US, companies with market capitalizations of US$140 million to US$1.8 billion at the time of purchase. At 8:30am, Ziehl meets with 10 sector analysts who manage chunks of the fund to discuss who should be allocated more money and from whom it should be taken. "Capital allocation is a group decision, but it's driven by the number of ideas that each sector manager has at that time," he said.
The group looks for small companies with strong market share in high-growth industries like technology and health care, ideally with solid balance sheets and improving profit margins. "These companies are in the growth phase and their actual margins are often very low because they're reinvesting in the business," Ziehl said.
An important factor is a company's ability to finance growth internally. "The equity markets are fickle," he said. "If the industry is out of favor, it suddenly becomes difficult to raise capital and the business plan is halted for lack of money."
Ziehl also prefers companies with little debt, generally a ratio of debt to capital well below 50 percent, depending on the industry.
In the smaller companies, strong management is particularly critical. "A lot of small-cap growth is salesmanship," he said, "so they need to be able to clearly communicate their vision to get the stock price going."
Another plus: substantial ownership of company shares or options by managers.
Ziehl prefers shares with price-earnings ratios equal to or below a company's projected five-year earnings growth rate, so he wants a P/E of 20 or less for companies with 20 percent growth rates. He limits purchases of any one stock to 0.5 percent to 2.5 percent of the fund's assets, and manages risk by starting to trim when they exceed 4 percent.
In July, Ziehl bought more shares of Axcelis Technologies. Axcelis produces equipment used in manufacturing semiconductors.
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