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June 16, 2020, 3:09 p.m. EDT

Robinhood traders could learn from this growth-stock investor who’s beaten indexes by a wide margin for years

Don’t let beginner’s luck fool you into making a painful mistake. John Malooly of Wasatch Ultra Growth explains how to pick winners and prevent your portfolio from blowing up

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By Michael Brush, MarketWatch


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If you’re hitting a lot of trades right on the Robinhood trading platform, be careful of hubris.

Overconfidence kills returns.

If you need a little something to spark your humility, consider this investor’s record. John Malooly, who manages the Wasatch Ultra Growth fund /zigman2/quotes/207685801/realtime WAMCX +1.81% , has beaten his small-growth category and the Russell 2000 Growth Index /zigman2/quotes/210598133/delayed XX:RUO +1.40%  by an annual average of 11.5 to 19.5 percentage points over the past three to five years, according to Morningstar. The fund is ranked No. 1 in its category for total returns over the past three years, per Morningstar.

If you’re new to investing, let me tell you: You don’t often see such a good long-term record. Few people consistently beat broad indexes, such as the S&P 500 Index /zigman2/quotes/210599714/realtime SPX +0.24% , the Dow Jones Industrial Average /zigman2/quotes/210598065/realtime DJIA +0.13% or Nasdaq Composite Index /zigman2/quotes/210598365/realtime COMP +0.92% .

I always wonder what I can learn from performers like these, so I recently talked with Malooly to find out. Here are the key takeaways.

Go for big growth

Malooly likes to have an average revenue growth of 20% in his portfolio. This looks risky because it’s about 8 percentage points higher than his benchmark index, according to Morningstar. But his portfolio is a deliberate mix of supercharged growth names in areas like tech and sectors you don’t normally associate with growth to offset the risk.

In supercharged tech, he favors plays on the “digitization of businesses,” like Zendesk Inc. /zigman2/quotes/209571012/composite ZEN +0.50% in customer-service software. Others here include DocuSign Inc. /zigman2/quotes/205992027/composite DOCU +1.21% in digital-signature documents, Five9 Inc. /zigman2/quotes/209043265/composite FIVN +4.67% in cloud-based call-center software, and HubSpot Inc. /zigman2/quotes/209389444/composite HUBS +4.38% , which helps smaller companies use the internet and digital marketing.

Meanwhile, he also goes with “safer” companies that have lower growth, but less propensity to blow up. For example, you rarely see grocery stores in growth portfolios, but he holds Grocery Outlet Holding Corp. /zigman2/quotes/212776733/composite GO +1.56% . The off-price grocery chain posts 10% sales growth, in part, by enticing entrepreneurial store managers with generous profit splits and lots of operational freedom.

Favor defensive growth

“Just buying fast-growing companies is high risk,” says Malooly. They can get hurt even on a small misstep. One way to cut risk: Avoid debt. “With faster-growing companies, leverage is not an asset,” he says. “They should be self-funding. Fast-growing companies with leverage tend to blow up, and you are not going to see the signs of stress until they blow up.”

He also looks for recurring revenue. About half the stocks in his portfolio have this. “When you get hit in companies that have recurring revenue, you are down 20% to 30%, not completely blown up,” he says.

This can come in the form of subscription revenue like at Paylocity Holding Corp. /zigman2/quotes/206986696/composite PCTY +2.72% , which offers cloud-based human-resource-management software. Paylocity serves small businesses hit hard by the lockdown. “But even if they don’t grow next quarter, I’m not looking at them being down 90%,” he says, because of the subscription revenue.

Repeat revenue also comes from follow-up maintenance and supply sales. Here he cites Kornit Digital Ltd. /zigman2/quotes/201434077/composite KRNT +0.76% , which sells printers and ink used for “fast fashion” and sports team apparel.

He even finds repeat revenue in biotechnology. The DNA-based cancer-screening tests of Exact Sciences Corp. /zigman2/quotes/206653925/composite EXAS +2.00%  get re-administered every few years. “The hurdle to grow is a lot lower than it appears,” he says. Another is Tandem Diabetes Care Inc. /zigman2/quotes/208680527/composite TNDM -0.49% . Its insulin pumps have to be replaced every few years.

Otherwise, cut risk by resisting the temptation to chase stocks. And buy when temporary issues knock a good stock down. For example, in May 2019 Trex Co. /zigman2/quotes/201322961/composite TREX +1.54%  reported manufacturing issues in a new line of decks. That seemed like a fixable problem at an otherwise good company, so Malooly bought the weakness. It is now “a double,” meaning the price rose 100%.

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