Wasatch Advisors’ CEO is a rare breed: a small-cap lifer who buys and holds – and avoids risk. Here’s what he’s buying now.
For Jeff Cardon, small is big. Cardon has been running the Wasatch Small Cap Growth Fund (WAAEX) since its 1986 inception. In fact, Cardon, 54, who’s also chief executive of Salt Lake City-based Wasatch Advisors, has never worked at any other firm (his only other job was driving a bread truck during college). That longevity fits Wasatch’s style: Cardon likes to buy small-cap growth stocks that can stay in the portfolio for a decade, growing 15% a year or more. The strategy has paid off for investors. The $1.5 billion fund (currently open only to new investors directly through Wasatch) has returned an average of 6.1% over the past decade, compared with 5.0% for the category and 2.7% for the S&P 500, according to Morningstar. Cardon sat down with Fortune to talk about why the key question today is not large cap vs. small cap but safety vs. risk, why he’s looking overseas, and why a trucking company is one of the best-managed corporations he’s seen in 30 years in the business.
You’ve been through numerous small-cap cycles. Where are we now, and what do you expect going forward?
The small-cap universe runs the gamut from the worst-quality companies that don’t make money and have horrible balance sheets to the best companies with better balance sheets than the average S&P 500 company. There is a small-cap cycle, but I’m not sure it’s relevant. It’s not the paradigm that matters. You should be thinking about safety. There’s not an index of companies that have no debt on their balance sheets and are throwing off excess cash flow, right? That’s the index you need to own if you want to own stocks now. In a world of more risk and a lot of leverage that is deleveraging, things are going to blow up. A company with no debt that’s making a profit cannot go bankrupt.
Your focus on safety is unusual for a small-cap manager, as is your portfolio, with its low turnover and holdings that have been in it for years. What’s your strategy?
What percentage of the portfolio, by weight, are brand-new names during the year? That’s how I think of turnover. Last year the number was 12%. That’s how I judge whether I’m being careful. If you have a high turnover of names, then you’re saying there’s a lot of stuff in the portfolio you don’t know very well. If you look at my top 10 holdings, there are companies that have been in the portfolio for 15 years. That’s way weird. But that’s our whole thing. We’re trying to figure out which are the really great companies, and over time they’ll work their way up through the portfolio. Knight Transportation (KNX), Power Integrations (POWI), Copart (CPRT), and Hibbett Sports (HIBB) have been there over 10 years. Peet’s Coffee & Tea (PEET) has been there eight. O’Reilly Automotive (ORLY) has been there over 15. We spend a lot of time with these companies, and we think they’re special. The lower weights are like the farm team, and the more we get to know them and like them, the more we’ll add to our holdings.
I don’t think of trucking companies as growth stocks, yet Knight Transportation is your top holding.
Knight is one of the best-managed companies I’ve known in 30 years. In a world of low growth and a lot of change, that’s more important than ever. Knight is the best trucker in the U.S. It has super-high margins for a trucker and a great track record of growth. The trucking industry is a $250 billion industry. So you’ve got a relatively small company in a huge industry. I really like that. The other dynamic is that the industry is shrinking because a lot of trucking companies are over-leveraged and a lot of the founders of mom-and-pop companies who grew up in the post-World War II period are reaching retirement age. So companies like Knight, I am very confident, will take market share in a big way. Even though it’s a trucking company and it doesn’t sound sexy, it’s a true 10-year growth story.
You mentioned that your portfolio includes Peet’s Coffee. What’s your thinking there?
Peet’s is a really well-managed company, with no debt and a great brand. It’s a huge industry — $50 billion worldwide if you include tea and coffee — and Peet’s has about $350 million in revenue. If it doubles in the next five years, that’s a 15% growth rate. That’s not heroic. Peet’s doesn’t even have to take share from Starbucks (SBUX), because it’s such a big industry. The stock’s not cheap, but there’s a margin expansion story too. I expect Peet’s to grow the top line 10% to 15% and the bottom line 15% to 20%. As margins expand, investors could make a lot of money on the stock. And in five years it’s not like this thing is dead; it’s a $700 million company in a $50 billion industry. That growth profile is under-appreciated when everybody is looking out about two seconds.
Technology represents about a quarter of your portfolio. That seems like less of a long-term play than what we’ve been talking about.
We’re growth managers; we want to own technology companies. There are some companies where we’re really attracted to a 30% growth rate, but with that kind of growth you’ve got a lot of risk and change. So we’ll invest, but we won’t think they’ll move up to the top 10. NetSuite (N) is a perfect example. It sells enterprise-resource-planning software in the cloud. ERP systems are super-expensive, and there’s a pretty high level of dissatisfaction with them. Ten years ago — maybe even three — nobody would’ve thought that was a real market. While people still debate whether or not it’s going to move to the cloud, NetSuite’s backlog is increasing. It’s a classic technology-disruption company.
A few of your stocks were acquired this year. Is M&A a continuing theme?
M&A has happened more than average for our portfolio. In a world starved for growth, growth companies are very attractive. Broadcom (BRCM) was willing to pay a lot for NetLogic Microsystems, which makes sophisticated chips that help the Internet move data around. It can grow in any environment. Another holding of ours, LoopNet (LOOP), is also being acquired at a big premium. We had the same thing happen overseas. We own a Chinese candy company called Hsu Fu Chi International. It’s a play on Chinese consumption and a known brand. And Nestlé is acquiring it. It’s kind of a bummer because the stock was not so easy for us to acquire, and a candy brand in China is probably a 10-year growth story. Nestlé saw the same thing.
You’ve made a large bet on international. Why?
We look at the world as without borders. That’s the way business is conducted. The firm has about one-third of assets outside the U.S. Our international team will bring up an idea, and we’ll say, “Well, that’s exactly like this company we invested in here in 1985.” And today small-cap stocks internationally are cheaper than they are here. The Indian market, in dollar terms, is down 35%, yet India is growing faster than the U.S.
More Fortune Investor’s Guide 2012
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Being a boring investor … and loving it
This article is from the December 26, 2011 issue of Fortune.
