So you've got a portfolio chock-full of white-hot stocks. And no wonder. The companies' sales and earnings have been skyrocketing. You've got what Michael Carmen, manager of the $366 million Harbor Mid Cap Growth fund, calls a "pretty portfolio." But he's not interested in something that's merely "pretty."
The pretty portfolio is when you've got "a lot of really nice-looking companies, but not at the point where you make the big money," he explains. "Most people think it's a good company when they see peak revenue and earnings. It will continue to have good growth, but decelerating growth." Carmen wants to buy a stock at the beginning of the "tailwind" of growth that pushes a stock's value from small potatoes to something that people are really talking about.
And that period of tailwind, Carmen says, is the "sweet spot," the point at which the money really rolls in. His fund seems to be in a fairly sweet spot right now. It's up 27.5 percent year to date, beating the S&P 500 by 16.6 percent and other mid-cap growth funds by 6.5 percent. It has grown 20 percent over the last five years (8.2 over the S&P) and 19.1 percent over the last three years (10 over the S&P).
For Carmen, the secret to catching the tailwind is looking ahead: "I'm not concerned about the next quarter. I'm concerned about what's happening in 2009." He says his fund hit one of those sweet spots earlier this year based on bullish forecasts the fund's analysts had made last year about corn prices. So Carmen invested in companies that make phosphate and nitrogen products used by farmers as nutrients. "Many of those stocks now have quadrupled or tripled, but now we're paring back," he says.
But looking that far ahead is not a simple process. Carmen says forecasting growth of a stock requires "holistic" knowledge of both the insides of the company and its industry.
Take one of his fund's major holdings in the retail industry, BJ's Wholesale Club, a Massachusetts-based warehouse club chain that operates 173 stores on the East Coast. The company's sales were suffering after a management change. But Carmen met with the company's brass and was impressed with the turnaround steps the execs were planning, such as improving its sales of perishable goods.
This new strategy paired with what Carmen's analysts thought was the key to success in the retail market. "Perishable goods are very important because they're the items people go back for," he explains. As a result, the fund's analysts forecasted growth for the stock "well above the consensus of the street" at the time, and Carmen bought the stock a few months ago. For the year, it's risen roughly 13 percent.
Carmen's focus on little-noticed firms taking control of their destiny has led to a diverse portfolio of 82 to 100 stocks where no sector dominates. The biggest sectors are industrial materials at 21.7 percent, and business services at 17.1 percent. It's also a fluctuating portfolio. "I don't believe in core holdings," he says. "If we don't expect business to bounce back quickly, my view is it's better to sell the company and move on to a better situation than be in the situation where we're hoping the company does well."
Another stock that Carmen likes is Focus Media, a Chinese advertising network that's traded on the Nasdaq. It designs digital advertisements that can be seen in supermarkets and office building monitors, among other places. He says his fund's study of the advertising market in China is emblematic of his detailed valuation process. "Our analyst looks at many variables—how much can they get per monitor per day, how many office buildings are there, what's happening to advertising ratios, etc."
Focus is Harbor Mid Cap's third-biggest holding at 1.98 percent. The largest is clothing accessory manufacturer Fossil at 2.15 percent, followed by video game designer and publisher Electronic Arts at 1.99 percent.
How does Carmen plan to keep that growth going? "I'm not afraid of buying a stock that other people aren't saying is a growth stock," he says. But he also stresses that once a stock has hit its "sweet spot," he has to be willing to let it go to focus on other opportunities. "The half-life of growth companies is shorter than people think. After all, he says, "the longer term is made up of a series of short terms."