Needhman on Investing Using Peter Lynch’s One Up on Wall Street as Guide

Needhman on Investing Using Peter Lynch’s One Up on Wall Street as Guide

ValueWalk Staff

Lynch devotes an entire chapter to the tenbagger.  A tenbagger is a stock that goes up tenfold.   ”The most fascinating part of any of these fast-growth retailing stories…is how much time you have to catch on to them.” Lynch cites Wal-Mart (WMT), the Body Shop and Toys R Us (now private) as examples in which an investor had years to buy the stock and still achieve tenbaggers. Lynch loved small cap stocks for their tenbagger potential.  We are also big believers in small caps.  Except during unusual market conditions, Chris Retzler’s Needham Small Cap Growth Fund (NESGX) has 80% of its assets invested in small caps.  As of September 30, 2012, the Needham Aggressive Growth Fund (NEAGX) had 61% of assets in small (between $250 million and $2 billion market cap) and micro cap (under $250 million) and the Needham Growth Fund (NEEGX) had 47% invested in small or micro caps equities.Our Process

In our search for tenbaggers at Needham, we look for:

Management teams that have previously created shareholder value (preferably at the company we are considering);

Businesses that participate in large markets with the opportunity to grow into much larger companies;

Attractive valuations;

Unrecognized product and margin expansion potential;

Post-IPO companies with venture capital backing; and

Companies with little research coverage.

The Needham Funds currently own three tenbaggers:

Precision Castparts* (PCP) is an aerospace components supplier purchased by NEAGX over ten years ago.  Mark Donegan, CEO, became EVP of Precision Castparts in 1992 and CEO in 2002.  In 2002, the company earned $0.80 per share after extraordinary items.  In the fiscal year ending March 2012, Precision Castparts earned $8.05 per share.  The company saw a fragmented aerospace supply base and the opportunity to bring scale to the market.  It has done a great job of growing and acquiring its businesses. The stock has appreciated from $10 per share to $189 per share.   In 2002, PCP was a small cap equity with a market capitalization of about $1 billion; today it is a large cap with a market capitalization of $26 billion.

NEAGX has owned Apple* (AAPL) since 2006, when it had a $50 billion market cap.  Today’s market cap of over $500 billion is down from the $700 billion market cap of earlier this year.  Apple has had continuity of management with Steve Jobs and his long-time lieutenant, Tim Cook as CEO.  Looking back to 2006, Apple had unrecognized potential in new markets beyond the iPod and Mac computers and the opportunity to be a much larger company.

CEO George Paz joined Express Scripts* (ESRX) in 1998 and became President in 2003.  The company provides pharmacy benefit management services.  It addresses a large market and has been a winner owing to its ability to lower healthcare costs.  The company has also pursued a market consolidation strategy with its most recent merger in 2010 with Medco Health Solutions.  In 2002, Express Scripts had a $4 billion market cap and earned $0.32 per share.  It currently has a $45 billion market cap and is expected to earn $3.72 per share in 2013.

We’d like to highlight two of Needham Funds’ holdings that are currently threebaggers:

ViaSat* (VSAT) went public in 1996.  Yours truly was one of the first analysts to follow the company after its initial public offering.  CEO Mark Dankberg was a co-founder in 1986.   In 2004, the company had a market capitalization of approximately $700 million.  It designed satellite electronics equipment for defense and commercial customers.

In the late 2000s, ViaSat had an idea that would dramatically increase satellite capacity.  After finding that its commercial customers did not share ViaSat’s vision, Mr. Dankberg set ViaSat on course to launch and run its own satellite broadband business.  ViaSat-1 was launched earlier in 2012 and the Exede broadband service is now available throughout North America. It has as much bandwidth as all other North American commercial satellites combined.

We believe that ViaSat can be successful in this new market.  In 2004, ViaSat earned $0.68 per share as an equipment supplier.  Preliminary estimates for the fiscal year ending March 31, 2015 call for $2.81 per share.  Of course, ViaSat is full of risks: it has never marketed a consumer product and EchoStar/ Hughes Communications and others such as Dish Networks and even Verizon could improve their own offerings.

Edward Stack has served as CEO of Dick’s Sporting Goods* (DKS) since 1984, when the company had two stores.  Mr. Stack has been with the company since 1977 in positions that include store manager and merchandise manager.  Mr. Stack’s father, Founder Richard “Dick” Stack, retired in 1984.  In mid-2008 and early 2009, Dick’s Sporting Goods was a small cap company with a market capitalization of between $1 billion and $2 billion.  The current market capitalization of Dick’s is $5.7 billion.

Dick’s has gained share in the retail sporting goods market.  Sports Authority is the leading competitor and was taken private by Leonard Green & Partners in 2006 and we can imagine the debt load it carries.  As of October 31, 2012, there were 518 Dicks Sporting Goods stores, up from 419 in January 2009.  Estimates see 589 by January 2014.   We believe Dick’s has an opportunity to be a much larger company.

Even in the fiscal year ending January 2009, Dick’s Sporting Goods stayed profitable and earned $1.18 per share. Fiscal year 2014 estimates are for $3.30 per share in earnings.  We believe the Stacks provide vision and stewardship to Dick’s.  We are pleased to be their partners through our investment.

However, Dick’s also has its risks. While its e-commerce revenues grew at a 47% rate in the quarter ending November 2012, it represented only about 5% of sales.  Will Dick’s suffer the same “showrooming” fate as other retailers, where customers use the store to see ideas and then buy online?  We believe Dick’s provides a shopping experience driven by strong merchandising and will continue to succeed.

The Lynch Foundation

The Lynch Foundation, founded by Carolyn and Peter Lynch in 1987, provides assistance to programs, primarily in Massachusetts, with an emphasis on education; culture and historic preservation; healthcare and medical research; and religious and educational efforts of the Roman Catholic Church.  The Foundation was an early backer of Founder and CEO Wendy Kopp’s vision for Teach for America and was one of the original funders of City Year and Paul Farmer’s Partners in Health.  City Year partners with public schools to provide the extra people power to intervene and help at-risk students.  Paul Farmer’s life calling is to bring modern medicine to those without access, as profiled in Tracy Kidder’s best seller, Mountains Beyond Mountains.

“Generally, we like to find new organizations with good ideas and help them get through the start-up phase,” Carolyn explains.   So, the Lynch Foundation is looking for social enterprises that can be social tenbaggers!

Summary

We believe that this can be a golden age for investors.  Investing requires work, but it can be rewarding in more than a financial sense. We believe that individual investors can use their knowledge of the world, combined with some basic research to develop a competitive edge for investing in stocks.

Five years of equity outflows may have removed much of the speculation and excess valuation from the market.  The available information and the opportunities for investors have rarely been better.   Financial advisors play an important role along this journey. Call your advisor and pick out a few stocks to research, or a mutual fund that pursues these strategies.  There’s no time like the present to get started.

*The Needham Funds aggregate ownership as a percentage of net assets in the stated securities as of 9/30/12: PDFS 4.42%; EXA 0.10%; PCP 0.31%; AAPL 1.32%; ESRX 6.02%; VSAT 2.64%; DKS 1.03%.

The information presented in this commentary is not intended as personalized investment advice and does not constitute a recommendation to buy or sell a particular security or other investments.

The Growth Factor

Needham Funds’ Commentary

by John Barr

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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