(Marketwatch) If the actively managed mutual-fund business wants to stem the money flows to index-tracking exchange-traded funds, it needs more people like Paul Greene.
The portfolio manager of T. Rowe Price Communications & Technology Fund, Greene is an inspiration for skeptics who claim that “You can’t beat the market.”
Greene stands out. Over the past three- and five years, he’s beaten rival communications funds and the S&P 1500 Telecom Services Index by eight-to-10 percentage points, according to research firm Morningstar. Over the past 10 years the T. Rowe Price Group fund has surpassed these two benchmarks by seven percentage points. Greene deserves some credit for the decade-long record because he was an analyst at the fund before taking the helm in 2013.
An engineer by training who graduated from Stanford Business School, Greene chafes at the idea that there are investment rules “retail” investors can learn from him. He argues that company analysis is too nuanced, and all companies and situations are unique. That’s true to some degree. Yet a lengthy chat with him reveals patterns in his approach — rules we all can learn from and emulate. Here’s a roundup:
1. Look for the proverbial self-reinforcing fly wheel: Greene identifies companies that promise satisfying returns over the long haul, so he can buy and hold. “Once I find them, I just want to own them. I don’t try to trade in and out,” he says. The fund has an extremely low annual turnover rate of 7%.
To find long-term winners, Greene hunts for companies with a self-reinforcing fly wheel. This is a kind of perpetual motion machine that builds on itself, increasing revenue and profit margins over time. “The more success they have, the more success it creates,” is how he sums it up. This is an especially important quality for companies in the internet space, where growing big enough to survive is key.
Here, Greene points to Booking Holdings, once known as Priceline. The company has spent a lot of time running exhaustive A-B tests of web page features to “optimize every pixel” to convert more shoppers into buyers. This improved its quality score at Alphabet so that its rankings went up, making ads more affordable and more effective. This brought in more customers, which attracted more inventory. That made customers happier so they bought more, boosting Google rankings, and so on. The result was a 10-bagger for the fund from a stock that once seemed easy to write off.
Netflix is particularly attractive in the stock’s current pullback, Greene says. Subscriber growth increases content budget, and more content draws more subscribers. The key here is that the amount Netflix spends on content is growing more slowly than the subscriber base. This means it squeezes ever more profit out of the content, over time. Netflix also has an edge over competitors because it’s applying this formula globally.
About Amazon.com, Greene notes that third party sellers, Amazon Prime, and algorithmic product suggestions all reinforce each other by making the site more convenient, which attracts more customers.
In software, various offerings on product platforms set up self-reinforcing sales growth at holdings of his fund, including ServiceNow, Atlassian, Coupa, Workday and Salesforce.com.
2. Look for what the market gets wrong, then bet the other way: This is the heart of investing. Yet a surprising number of people like companies on the basis of what they do, ignoring how much of this is known by the market — which limits upside. It’s always preferable to understand consensus and then figure out if it’s wrong.
Cable companies Comcast, Charter Communications and SBA Communications offer a good example. They all have fairly healthy stock price charts. But their stocks would be higher if investors weren’t so worried about cord cutting. Greene says he isn’t concerned, because even if customers ditch cable, they’ll still need broadband. And since cable companies have limited geographic overlap, he adds, they each have near-monopolies, which reduces the risk of defections.
3. Don’t get shaken out of good positions: It’s easy to get spooked by stock pullbacks. The key to navigating through is understanding whether a business model is still sound. “That is half the battle. It’s not just identifying them. It’s not getting scared off the horse,” Greene says.
Facebook, Alphabet and Amazon.com are good examples. All of them currently are caught up in a regulatory and political firestorm. Greene thinks investors are taking the risks of government intervention too seriously. What’s his reasoning? On privacy and security, these companies are on the same side as regulators because their data on users is proprietary business intelligence they need to protect, Greene says. “There will be mishaps, but the companies are on the same page as the regulators. So I don’t see this as a big area of tension,” he adds.
Moreover, it will be tough for antitrust regulators to show that consumers are being abused. There’s no monopoly price-gouging since Facebook and Alphabet products are all or mostly free. Amazon has a strong case that it drives consumer prices down. The companies aren’t taking advantage of their powers to force consumers to use some features in exchange for others. “These companies have gotten to the scale they have because they have been focused on the consumer first,” Greene says. “It is going to be challenging for the government to build an effective antitrust case.”
On election campaign influence, Greene says he thinks it’s tough to make the case that Facebook content has a political bias. Says Greene: “They want to be neutral. It just makes business sense.”
As a business, Facebook continues to post solid usage growth thanks to popular features like “stories,” Greene points out. And there are plenty of services to monetize, including messaging, private social networks, WhatsApp, and payment systems. “There is a lot in the pipeline,” Greene says. “I have high degree of confidence the company can continue to grow healthily.”
Greene also thinks it would be a mistake to sell Alibaba because of U.S.-China trade war fears. Alibaba does most of its business in China, with fundamentals Greene describes as “fantastic.” The company’s online marketplace business is strong, he adds, and there’s potential with cloud computing, its Ant Financial unit, and offering logistics and business support to other retailers.
4. Put money in the path of mega-trends: This is another rule that’s too obvious to mention. But given Greene’s record, it’s interesting to consider how he applies it: the fund holds large stakes in cell-tower companies Crown Castle International and American Tower. “I own them because wireless broadband is growing dramatically,” Greene says. “It grows 30% year-in, year-out, because there are more games, higher fidelity video, and people spending more time on their phones.”
5. Make big bets: Taking large positions is a common practice among fund managers who outperform. Greene is no exception. Amazon.com, the fund’s top holding, was recently a 13.5% position. The next five each make up 5%-7% of the portfolio. The top 20 stocks represent 80% of the fund’s assets. “We like to find companies that can compound over a long time. And when we find them, we want to own a lot of them,” Greene says.
