By J.R. Brandstrader
If the Middle East and Japan have you thinking about bringing more of your portfolio home, the Needham Growth /zigman2/quotes/207226003/realtime NEEGX -0.60% Fund would be a reasonable destination. Long-time collaborators Chris Retzler and John Barr, co-managers of the $193 million fund, have posted solid returns by scouring the U.S. for strong companies that have been ignored by analysts and trade at a discount to the market. They are searching for stocks of all sizes with the potential to produce long-term capital appreciation.
Retzler, 39 years old, a Fulbright scholar and graduate of Columbia Business School, and Barr, 54, a Harvard Business School alum, also provide investment ideas for the $152 million Needham Aggressive Growth /zigman2/quotes/205686828/realtime NEAGX -0.04% Fund (ticker: NEAGX) and the $153 million Needham Small Cap Growth /zigman2/quotes/209699828/realtime NESGX -0.36% Fund (NESGX). In all, Needham Asset Management, based in New York, oversees more than $950 million in public- and private-equity investments.
As of March 31, Needham Growth's (NEEGX) performance had topped 93% of peers' returns over the trailing three years and 71% over five years. It has climbed 25% during the last year, far outpacing the 15.65% gain for the Standard & Poor's 500. The fund was up 11.94% for the three-year period, compared with the 2.35% rise in the broader market. For five years, it's risen 5.92%, versus a 2.62% gain for the S&P. Although it's a no-load, the fund's 2% expense ratio is higher than that of most peers. Needham Growth can hold stocks of any market capitalization, but the average weighted size was about $7 billion as of the end of 2010.
The twosome play broad themes and adapt their investment criteria to particular industries. For instance, in technology, they zero in on product cycles and unit growth, but in health care, they pay more heed to demographic and lifestyle trends as well as regulation. They sell when a stock hits its target price, or assumptions supporting their original investment thesis change. That might include a change in management or a product that fails to be widely adopted. In any case, they adhere to co-founder George Needham's style. "He takes a long-term view and guides us to have patience on our investments," says Retzler.
The Needham shop makes a point of maintaining good contacts in the venture-capital community and among young companies. "We try to meet them while they are still private, so that when they go public, we are prepared," says Barr. The firm also runs a growth-stock conference, which gives the managers a chance to meet with hundreds of public companies and get to know their businesses.
The firm has a particular interest in semiconductor shares. One they like is San Diego-based Entropic Communications /zigman2/quotes/205959201/composite ENTR -0.0081% (ENTR), a leading manufacturer of chips designed to enable set-top boxes and other devices to handle data communication and multimedia streaming. The proliferation of home-networking gateways is a favorite Needham theme. The chips that make it possible use a standard known as the "Multimedia Over Coax Alliance," or MoCA. TVs, computers, and other networked devices will all have to have MoCA-compliant chips, as will the new generation of multiroom DVRs that companies such as Verizon /zigman2/quotes/204980236/composite VZ +0.50% , (VZ), Comcast (CMCSA) and Time Warner Cable (TWC) are beginning to offer.
Entropic went public at 6 in 2007, but the shares have traded below that for most of their existence. Needham Growth bought at about 3 in early '10; the shares since have climbed to a 52-week high of 13.96 in January before falling to a recent 8.45. "The stock has corrected based on headwinds that are probably misunderstood. They have $1.85 per share in cash and no debt and few competitors," says Barr, adding that Entropic can earn 85 cents in '11 and 92 cents in '12.
|NEEGX /zigman2/quotes/207226003/realtime NEEGX||25.40%||11.94%||5.92%|
|Top 10 Holdings||Ticker||Portfolio**|
|Thermo Fisher Scientific /zigman2/quotes/201150432/composite TMO||TMO||3.98|
|CarMax /zigman2/quotes/204412041/composite KMX||KMX||3.59|
|Entropic Communications /zigman2/quotes/205959201/composite ENTR||ENTR||3.10|
|Brooks Automation /zigman2/quotes/200082753/composite BRKS||BRKS||2.91|
|Seagate Technology /zigman2/quotes/201824240/composite STX||STX||2.82|
|Varian Medical Systems /zigman2/quotes/203738795/composite VAR||VAR||2.82|
|Becton Dickinson and Co. /zigman2/quotes/205527610/composite BDX||BDX||2.49|
*As of 3/31/11; three- and five-year returns are annualized. **As of 12/31/10.
Sources: US Bancorp Fund Services; Morningstar; Bloomberg
Another favorite theme is the technological change driving demand for semiconductor manufacturers' capital equipment. Needham believes Billerica, Mass.-based Entegris /zigman2/quotes/200628784/composite ENTG -0.94% (ENTG), which supplies equipment and materials for making semiconductors and flat-screen panels, has lots of upside. Needham purchased at about 1 a share, then again at 4.
"The company has $1 per share of cash and has paid down debt," says Retzler. Entegris, he says, should benefit as its customers resume building new plants. He and Barr expect as many 10 to 15 new facilities to come on stream in 2011. "The newer the plant, the more Entegris products are needed," says Retzler. The stock recently traded at about 8.78. The managers put earnings at about 85 cents a share this year and 81 cents in '12, up from 71 cents in '10. (There are only three estimates on this stock.) They agree that new plant starts will slow in 2012, but think other parts of the business, such as making containers to transfer wafers, should hold up well.
Their Allscripts Healthcare Solutions /zigman2/quotes/208834131/composite MDRX +3.28% (MDRX) investment is a bet on changing regulations. The company provides software and services, including electronic health records, for physicians and hospitals. It should be a big beneficiary of the government's Health Information Technology for Economic and Clinical Health Act, which pushes the adoption of electronic-health records.
"They bring a uniform solution for doctors and hospitals, which could help drive fraud out of the system," Retzler says. They started buying the stock at about 17, and it's since risen to 20.99. Retzler still likes it because government monies are just becoming available this year. Wall Street expects earnings per share of 90 cents in 2011 and $1.06 in 2012.
The recovery in the economy and advertising has increased demand for digital printing, and that should be good for Electronics for Imaging /zigman2/quotes/203570515/composite EFII -0.03% (EFII). The company makes controllers that turn printers at global companies like FedEx into networked devices that can spew out copies in a variety of locales.
Needham Growth first snapped up the shares at 11 in the first quarter of 2010 and added more in the second and third quarters. The company has $4.82 per share in cash, and its earnings are expected to come in at 91 cents a share in 2011 and $1.08 in 2012, up from 59 cents in 2010.
Retzler and Barr put fundamentals first, but they readily concede that macro trends can have a big effect on a stock's performance. The biggest wild card right now is monetary policy, they say. If the Federal Reserve remains accommodative, stocks should continue to rally—and that includes U.S. growth stocks.