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April 25, 2020, 11:56 a.m. EDT

7 stock picks for a volatile market from a manager who ‘finds innovation all over the place’

The Buffalo Discovery Fund’s Dave Carlsen on seven stock picks, from video-game makers to water-purification companies

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By Philip van Doorn, MarketWatch


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You may have read stories about investment strategies tailored for down markets that have succeeded as the bull market in stocks ended this year.

The Buffalo Discovery Fund’s Dave Carlsen has steered the $1.4 billion fund to index-beating performance through thick and thin. The Discovery Fund /zigman2/quotes/200702268/realtime BUFTX -0.56%  is rated four stars (out of five) by Morningstar and is typically invested about 70% in mid-cap stocks.

“The good thing about our process is we have already thought about the worst of times,” he said in an interview April 21.

“We want to identify long-term trends, make sure our companies can benefit from those trends, and manage to the trends, rather than to a benchmark,” said Carlsen, who started in the investment industry as an analyst in 1992.

We have compared the fund to two index benchmarks, and you can see its outperformance below.

Buffalo Funds is based in Mission, Kan., and has $3.5 billion in assets under management. Carlsen has been a portfolio manager of the Buffalo Discovery Fund since January 2004 and is now its sole manager.

Carlsen described a three-step investing process.

1. He and colleagues identify long-term innovative trends “that the market accepts,” and then pinpoint “market disrupters,” which are companies with growing market shares within those innovative industries.

“We look for trends up and to the right, rather than cyclical or mature companies,” he said.

2. Carlsen and his team use fundamental analysis to screen for companies with high profit margins, “scalable business models” and “balance sheets that can fund growth in good times and bad and a strong management team that can transform that secular opportunity into value for the shareholder.”

3. The fund picks investments based on stock selection. Carlsen and his team will look out five to seven years and establish best-case and worst-case scenarios with price-target ranges. “Best/worst provides a band of price targets that we think are possible. The band should be moving up and to the right, and the downside should too,” he said.

Here are seven examples of stocks held by the fund that Carlsen discussed:

Take-Two and Activision

Carlsen called Take-Two Interactive Software /zigman2/quotes/204008930/composite TTWO -0.71%  and Activision Blizzard /zigman2/quotes/200717283/composite ATVI +0.10%  “beneficiaries” of this year’s stay-at-home and social-distancing behavior meant to curb the spread of COVID-19. Shares of Take-Two have returned 4% this year, while Activision is up 13.5%. The broad indexes are down significantly, as you can see in the table below.

“They should put up good numbers this year. Even though we have had demand destruction elsewhere, this is an area where demand can hold up,” he said, adding that there is a longer-term “tailwind” for both video-game developers because of the coming upgrade cycle for Microsoft’s /zigman2/quotes/207732364/composite MSFT -2.18%  Xbox and Sony’s /zigman2/quotes/208567357/composite SNE +1.55%  PlayStation.

Chewy

Chewy /zigman2/quotes/212690528/composite CHWY -3.99%  is known for providing excellent customer service and has “less than a 10% share of total pet spending, expected to be $85 billion in 2020,” according to Carlsen. The online-pet-food service, which provides all sorts of other pet supplies, is an obvious beneficiary of the COVID-19 lockdown. The stock is up 55% this year.

“Total pet spending grows by 4% to 5% each year. The primary driver is people are pampering their pets more than ever. Chewy is a very strong disrupter” to capture a significant portion of the move to online spending, Carlsen said.

SBA Communications

SBA Communications /zigman2/quotes/208397406/composite SBAC -1.40%  owns wireless towers and leases space on them to multiple tenants using various technologies.

/zigman2/quotes/200702268/realtime
US : U.S.: Nasdaq
$ 26.45
-0.15 -0.56%
Volume: 0.00
Sept. 17, 2020
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/zigman2/quotes/204008930/composite
US : U.S.: Nasdaq
$ 158.32
-1.13 -0.71%
Volume: 872,452
Sept. 18, 2020 2:11p
P/E Ratio
40.60
Dividend Yield
N/A
Market Cap
$18.23 billion
Rev. per Employee
$574,279
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/zigman2/quotes/200717283/composite
US : U.S.: Nasdaq
$ 78.85
+0.08 +0.10%
Volume: 4.47M
Sept. 18, 2020 2:11p
P/E Ratio
33.61
Dividend Yield
0.52%
Market Cap
$60.80 billion
Rev. per Employee
$756,869
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/zigman2/quotes/207732364/composite
US : U.S.: Nasdaq
$ 198.48
-4.43 -2.18%
Volume: 31.41M
Sept. 18, 2020 2:11p
P/E Ratio
34.46
Dividend Yield
1.13%
Market Cap
$1535.55 billion
Rev. per Employee
$902,473
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/zigman2/quotes/208567357/composite
US : U.S.: NYSE
$ 78.81
+1.20 +1.55%
Volume: 771,050
Sept. 18, 2020 2:09p
P/E Ratio
16.09
Dividend Yield
0.39%
Market Cap
$94.85 billion
Rev. per Employee
$654,652
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/zigman2/quotes/212690528/composite
US : U.S.: NYSE
$ 52.25
-2.17 -3.99%
Volume: 5.31M
Sept. 18, 2020 2:11p
P/E Ratio
N/A
Dividend Yield
N/A
Market Cap
$22.13 billion
Rev. per Employee
N/A
loading...
/zigman2/quotes/208397406/composite
US : U.S.: Nasdaq
$ 307.96
-4.39 -1.40%
Volume: 275,706
Sept. 18, 2020 2:08p
P/E Ratio
N/A
Dividend Yield
0.60%
Market Cap
$34.96 billion
Rev. per Employee
$1.39M
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