Want to know how MFS Growth Fund (MFEGX) outperformed 75% of its large-cap growth peers this year? Look at its portfolio, rich in leaders, featuring the entire cast of FAANG stocks — Facebook (FB), Amazon.com (AMZN), Apple (AAPL), Netflix (NFLX) and Google parent Alphabet (GOOGL) — as of Sept. 30. Their year-to-date gains range from Alphabet’s 34% to Netflix’s 59%.
XAutoplay: On | OffThose FAANG stocks help make technology the fund’s largest sector, with a 28% weighting. Among the fund’s other tech stocks are big contributors such as digital media and marketing software firm Adobe Systems (ADBE) and graphics-chip maker Nvidia (NVDA). Those two are up 79% and 96% respectively.
The fund’s diversification helps too. Big contributors include nontech names like cosmetics maker Estee Lauder (EL), which is up 61% this year. All together, the fund was up 29.4% in 2017 going into Thursday, according to Morningstar Direct.
That’s well above its 2.21% gain for all of 2016. “We were doing well for most of 2016, but (we) lost a lot of ground in November on the ‘Trump Trade,’ ” said co-manager Paul Gordon. He was referring to the late 2016 stock market rally in which many investors favored lower-quality, more-cyclical stocks that they expected would benefit from policies enacted by a Republican White House and Congress.
But the fund caught up big-time when investors started favoring growth stocks at the beginning of the year.
The fund’s performance relative to its large-cap growth peers tracked by Morningstar Direct has slipped somewhat in the past three months too. “September ’17 was a lighter version of the same (low-quality, cycle-focused) trade on the prospects of tax reform, which set us back a little that month,” added Gordon. “However, we maintain our focus on owning cross-cycle, above-average growers.”
That translates into seeking stocks whose growth is above average and is sustainable no matter which way the political winds blow. “We are looking for stocks that can grow earnings and free cash flow at rates above the market’s growth for the long duration,” Gordon said, referring to himself and co-managers Eric Fischman and Matthew Sabel.
Gordon likes the long runway that he sees still in front of Nvidia. “The thesis here is that Nvidia is exposed to some of the areas of technology with the largest potential addressable markets, and they have strong competitive market strengths in each,” Gordon said.
Nvidia chips have been popular in gaming, which provides about 60% of the firm’s sales, Gordon says. In addition, data center operators have seen in recent years that strings of GPUs (graphics processing units) can power their computer needs more efficiently than regular CPUs, so now Nvidia’s GPUs are being used in high-performance data centers, machine learning and driverless automobile functions.
“Growth has accelerated in their data center business as well as in their autonomous-driving business,” Gordon said. “Nvidia has leadership in each. And it’s able to spend to build share in each.”
Adobe’s earnings per share (EPS) growth has accelerated, rising 42%, 44% and 47% in the past three quarters.
Gordon likes the stock’s strategic position. “We like the market they’re in and their transition to subscriber selling (from legacy software),” Gordon said. “It expands the number of people who’ve bought the product, it reduces piracy, it makes revenue more recurring and it improves free cash flow conversion.”
Gordon likes the firm’s rate and duration of growth, which he says should lead to higher incremental margins.
IBD’S TAKE: You can see how Adobe’s strengths — like its 48% three-year EPS growth rate — stack up against its peers’ at the stock’s easy-to-read IBD Stock Checkup page.
Netflix EPS grew at a triple-digit clip in three of the past four quarters. The fund has built its stake in recent portfolio disclosures.
Gordon expects the internet content distributor to keep doing good things in the near term. “They’ve been able to offer an incredible amount of content at attractive prices,” he said. “So they’ve done a tremendous job of raising their subscriber base in the U.S. and internationally. That’s led to an ability to get pricing (increases) because they provide value.”
Gordon added, “We think there are still huge opportunities for (their subscriber) number to grow in the coming year.”
Amazon is another name in which the fund has boosted its stake in recent disclosures. He likes both halves of its business. “We think of Amazon as almost two companies within one,” he said, citing Amazon Web Services and the firm’s e-commerce side. “We see potential for both businesses to be much bigger down the road.”
Nor is Gordon antsy about Amazon’s hefty investment spending. “Amazon has always spent and typically run fairly low margins, and it’s paid off over time,” he said. “It’s an area to watch. But they have earned the trust of investors that their investments will pay off in time as future market-share gains.”
Facebook is a third name in which the fund has been building its stake. “The core Facebook business is still growing at a high rate,” he said. “And they’ve only started to monetize businesses like Instagram and WhatsApp.”
Facebook has also positively surprised many investors. “About a year ago they guided that the core business could decelerate as they slowed ad loads — ads that you see in Facebook streaming. But demand has been so strong that revenues this year are coming in better than the market expected.”