Investing in All-Season Large-Cap Growth StocksFebruary 19, 2019
- Mr. Puglia seeks companies that can sustainably compound earnings and generate free cash flow growth at a strong rate.
- At the start of 2019, there were significant market risks and more challenges than
a year ago.
- The fund entered 2019 with overweight positions in consumer discretionary, health care, and communication services stocks.
Larry Puglia has managed the Blue Chip Growth Fund for more than 25 years, a remarkable feat. He also has been twice nominated for Morningstar’s U.S. Domestic‑Stock Fund Manager of the Year award.1 In this interview, Mr. Puglia discusses his consistent approach to managing the fund, his market outlook, and how the fund is positioned going into 2019.
Q. What are the key lessons you’ve learned in managing this fund for such a long time?
Among the many lessons is that no one has a monopoly on intelligence. So I try to learn from various sources and remain open to opposing views, innovations, or other disruptive developments.
Second, in investing in volatile markets, it is especially important not to dwell on mistakes or celebrate winning stocks. We strive to focus on investments’ values going forward. You also should realize that you only rarely are able to buy at the bottom and sell at the top.
Third, investing is not a popularity contest. If you buy the same stocks as others, you will get about the same results. Portfolios generally need to include at least a few controversial ideas. Being contrarian often can lead to significant investment gains.
We try not to confuse activity with true insight. Successful investing requires calm thinking. Recognizing mistakes early—and earlier than your competitors—is necessary. At the same time, it is important to not judge investment ideas over too short of a time horizon. The best ideas often take some time to be recognized by the market.
Diversification, as of December 31, 2018
Source: T. Rowe Price.
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...I try to learn from various sources and remain open to opposing views, innovations, or other disruptive developments.- Larry Puglia, Portfolio Manager, Blue Chip Growth Fund
Q. What’s your approach to running this fund, and how has it evolved?
Our approach to investing has remained consistent. Stock prices tend to follow earnings and free cash flow growth over time. As a result, we seek out companies with sustainable earnings and free cash flow growth.
We particularly look for high‑quality growth stocks that can sustainably compound earnings at a strong rate. These rare companies tend to have strong market share, large addressable markets, and—not to be underestimated—very strong managements that know how to allocate capital. They typically generate durable free cash flow growth.
We also prize companies with a high degree of recurring or service revenue and companies that are well diversified by product and geography. Warren Buffett talks about franchise businesses; Morningstar describes quality businesses as having a moat surrounding them; others call it a sustainable competitive advantage.
Last, we try to be aware of the fund's benchmarks [the S&P 500 and Russell 1000 Growth Indices] but not overly concerned about having investments in certain components. Some of our best decisions have been to avoid large components of the benchmarks that did not meet our criteria.
T. ROWE PRICE BEYOND THE NUMBERS
Relying on the Firm’s Research Platform
Seeking Franchise Businesses With Sustainable Competitive Advantages
We’ve consistently relied on the extensive research platform that T. Rowe Price continues to build and the firm’s environment of trust and collaboration among portfolio managers and analysts as we search for high‑quality growth companies that can sustainably compound earnings and free cash flow. We particularly seek companies with strong managements that allocate capital well, have a high degree of recurring revenue, and are franchise businesses with a sustainable competitive edge.
Q. What’s your market outlook for 2019?
At the start of 2019, there were very significant risks in the market and perhaps more challenges than existed at the end of 2018. I would put the unsettled trade negotiations with China at the top of our concerns, but some slowing in global growth also is noteworthy. Moreover, we’re evaluating the unsettled political environment in several countries, including Brexit uncertainties in Europe and the possibility of greater regulation from the change in the U.S. House leadership.
However, the basic building blocks of stock performance remain. Specifically, corporate earnings continue to grow at solid rates, and the revenue growth underlying earnings remains resilient.
It is true that corporate tax reform boosted earnings in 2018, and that will create more difficult comparisons. But valuations, which were becoming a significant potential impediment to future stock performance, appear more reasonable with time and the market pullback in the fourth quarter of last year.
Typical turnover rate for the Blue Chip Growth Fund.
Q. How was the fund positioned coming into 2019?
We entered 2019 with overweight positions in consumer discretionary, health care, and communication services stocks. We have experienced volatile markets and a significant pullback in technology, but also in several other sectors. However, the type of company in which we invest has not really changed significantly. Our turnover rate has run only about 30%, and many of our large positions entering 2018 continue to be large positions.
These include consumer discretionary stocks, such as Amazon and Alibaba; health care stocks, such as Becton Dickinson, Intuitive Surgical, Stryker, Cigna, and UnitedHealthcare; and technology stocks, such as MasterCard, Visa, PayPal, Intuit, and Microsoft. Several of our large holdings, such as Alphabet [formerly Google] and Facebook, have been reclassified into the new communication services sector, where we have an overweight position. So we actually are now underweight in technology after the latest sector classification changes effective in the fourth quarter of 2018.
We have strived to maintain ownership in a broad array of growth companies, and most of these companies are quite reasonably valued. For example, even stocks such as Amazon and Google, which had experienced strong, consistent revenue growth and solid stock performance, now trade at well below 20 times the free cash flow they may generate in 2020. However, we should point out that we own large positions in companies outside these sectors, such as Boeing and Ameritrade.
Q. What about sector underweights?
We have generally underweighted sectors and industries that are deeply cyclical and overly fragmented or where most of the participants do not earn their cost of capital. We also have avoided industries in which the competitive environment or structural changes are making consistent growth challenging.
Consequently, we now are underweighting the materials and industrials and business services sectors. We also have largely avoided the consumer staples sector as we believe that private‑label products will continue to be a significant threat to the pricing power of branded staples. And we have had very limited investment in the energy, utilities, and real estate sectors.
Q. What are the top risks these days?
We’ve already noted the risk of a broadening trade war with China, which could hamper global economic growth, as the most significant concern.
In addition, antitrust or data privacy issues or rhetoric directed at many of the internet leaders are certainly potential challenges. Slowing growth and greater regulation in China also could weigh on the growth of such holdings as Alibaba and Tencent. Finally, increased regulation from a divided Congress could affect such sectors as health care and financials.
However, our investment approach recognizes that it is very difficult to forecast how these macro factors will develop and how much they will affect stock prices. So we continue to emphasize companies that we believe can continue to generate strong earnings and free cash flow growth in most scenarios.
Essentially, we are trying to buy all‑season growth companies that we think can do reasonably well in most economic and regulatory environments. We acknowledge that a growth investment strategy may not be especially defensive relative to certain other strategies. However, over reasonable time horizons, we believe the quality and growth prospects of our holdings could provide relatively favorable prospects.
Essentially, we are trying to buy all‑season growth companies that we think can do reasonably well in most economic and regulatory environments.- Larry Puglia, Portfolio Manager, Blue Chip Growth Fund
Q. Last word?
It has been an honor to manage the Blue Chip Growth Fund for more than a quarter century. I especially appreciate the confidence that our clients have placed in our investment team by maintaining their investments and adding periodically, including during market turbulence. I also very much appreciate the extensive research platform T. Rowe Price continues to build and its unwavering commitment to research excellence.
WHAT WE’RE WATCHING NEXT
Valuations are more reasonable after the December pullback. However, investors face several key challenges, including the trade negotiations with China, slowing Chinese and global growth, rising U.S. interest rates, and possibly more regulatory scrutiny in selected industries. We believe corporate earnings will decelerate but still will be sufficient to drive meaningful stock performance for many stocks.
Call 1-800-225-5132 to request a prospectus or summary prospectus; each includes investment objectives, risks, fees, expenses, and other information you should read and consider carefully before investing.
1Established in 1988, the Morningstar Fund Manager of the Year award recognizes portfolio managers who demonstrate excellent investment skill and the courage to differ from the consensus to benefit investors. To qualify for the award, managers’ funds must have not only posted impressive returns for the year, but the managers also must have a record of delivering outstanding long-term risk-adjusted performance and of aligning their interests with shareholders’. Managers’ funds must currently have a Morningstar Analyst Rating™ of Gold or Silver. The Fund Manager of the Year award winners are chosen based on research and in-depth qualitative evaluation by Morningstar’s Manager Research Group. For more information about Morningstar Awards, visit https://go.morningstar.com/Morningstar-Awards.
As of December 31, 2018, Amazon made up 10.04% of the Blue Chip Growth Fund; Alibaba, 2.95%; Becton Dickinson, 1.99%; Boeing, 3.86%; Intuitive Surgical, 1.71%; Stryker, 1.95%; Cigna, 1.74%; UnitedHealthcare, 3.22%; MasterCard, 2.90%; Visa, 3.50%; PayPal, 1.72%; Intuit, 1.62%; Microsoft, 5.75%; Alphabet, 6.09%; Facebook, 3.84%; Tencent, 2.26%; and Ameritrade, 1.51%. Funds that invest in growth stocks are subject to the volatility inherent in common stock investing, and their share price may fluctuate more than that of a fund investing in income-oriented stocks.
This material is provided for informational purposes only and is not intended to be investment advice or a recommendation to take any particular investment action.
The views contained herein are those of the authors as of January 2019 and are subject to change without notice; these views may differ from those of other T. Rowe Price associates.
This information is not intended to reflect a current or past recommendation, investment advice of any kind, or a solicitation of an offer to buy or sell any securities or investment services. The opinions and commentary provided do not take into account the investment objectives or financial situation of any particular investor or class of investor. Investors will need to consider their own circumstances before making an investment decision.
Information contained herein is based upon sources we consider to be reliable; we do not, however, guarantee its accuracy.
The specific securities identified and described do not necessarily represent securities purchased, sold, or recommended and no assumptions should be made that the securities identified and discussed were or will be profitable.
Past performance is not a reliable indicator of future performance. All investments are subject to market risk, including the possible loss of principal. All charts and tables are shown for illustrative purposes only.
- Learn more about the T. Rowe Price Blue Chip Growth Fund.