David Scott, senior portfolio manager of Chase Growth Fund (CHASX), along with fellow manager Derwood Chase, uses both computer screens and basic judgment to find growth stocks with reasonable valuations. Scott especially looks at earnings, but so does most of the market, so he seeks companies with good prospects for at least one to two years.
The Chase fund's focus on reasonable growth has led it to finance and health care, but not technology, thus shielding shareholders from that sector's woes. For the three-year period through May, the fund rose an annualized 14.3%, versus 6.3% for the average large-cap growth fund. More recently, the fund was down 0.3% for the one-year period through May, while its peers lost 20.9%. The fund carries an S&P 3-Year Overall Rank of 5 Stars, which means that it has provided the best combination of risk and return versus its peers over that time.
The fund top finance picks include Fannie Mae (FNM), Golden West Financial (GDW), and Washington Mutual (WM). Its health-care holdings include Elan Corp. (ELN), Biomet Inc. (BMET), and Cardinal Health (CAH). One recent purchase: motorcycle icon Harley-Davidson (HDI).
Bill Gerdes of Standard & Poor's FundAdvisor recently spoke with Scott about the fund's investing strategy and its recent portfolio moves. Edited excerpts from their conversation follow:
Q: What is your basic investment philosophy?
A: We look for growth stocks that trade at reasonable prices. We believe earnings drive stock prices, but people often pay too much for earnings, so we also focus on valuations.
Q: How do you find growth stocks with reasonable valuations?
A: We combine a computerized process with investment judgment. First, we screen for stocks with at least 10% earnings growth for the last five years. Then, we look at returns on equity to identify companies with strong fundamentals. We also use technical analysis, such as relative strength and trading pattern volumes.
These screens give us about 40 to 60 names, from which we choose about 35 to 40 stocks. We spend most of our time judging the final candidates for the portfolio, looking for such performance drivers as management changes or margin expansions. We prefer strong trends that will last four to eight quarters. We tend to hold stocks for 12 to 18 months, giving us a turnover of about 65%.
Q: When will you eliminate a position?
A: We sell stocks when they become overvalued. At the last step of our buy process, we set buy/sell targets for each purchase. If a stock gets expensive, we put it on a watch list. We'll may raise the sell price for a stock, but sometimes you can't raise the target any higher. Deteriorating fundamentals or technical factors can also trigger a sale.
Q: Have you found opportunities as the market has come down this year?
A: We've found some, but not much in technology, which is still very overvalued. While a few tech stocks are showing up on our technical screens, their fundamentals are getting weaker.
Q: What sectors or industries are you currently focusing on?
A: Our portfolio tends to be very diversified, since we don't put more than 12% of the fund in a single industry. Financials has become a large area for us as the Federal Reserve has eased interest rates. We've moved into mortgage companies, savings and loans, and credit card companies. Our holdings include Fannie Mae, Freddie Mac (FRE), Golden West, and Washington Mutual.
Health care is another sector that has shown up in the process, particularly health-care supplies and pharmaceuticals. Elan, Biomet, and Cardinal Health are large holdings in these industries.
Q: Why have the fund's returns been strong this year and for the three-year period through May?
A: Our selection process has led us to finance, health, and aerospace/defense, while our sell discipline has kept us from technology.
Q: What are the fund's largest holdings?
A: Sysco Corp. (SYY), Tyco International (TYC), General Dynamics (GD), Cardinal Health, and Boeing (BA). We like Boeing because it dominates aircraft manufacturing and is expanding into defense. Sysco has strong fundamentals and good near- and intermediate-term earnings.
Q: What have you purchased recently?
A: Harley-Davidson is a smaller large-cap company that scores well across all aspects of our process, particularly earnings. From Standard & Poor's FundAdvisor