Chipotle, Cognizant: Stocks That Frank Caruso Likes

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There are two keys to Frank Caruso's investment strategy.

First, the lead manager of $2 billion AllianceBernstein Large Cap Growth directs his team to seek what he calls dynamic gaps.

Those gaps are big differences between how fast Caruso's team expects a stock's earnings to grow and Wall Street's consensus expectation.

The second key is where Caruso has his team look for that gap: four to five years out.

Caruso is adamant about avoiding a focus on the near term.

This approach had the fund up 32.46% this year through Nov. 30. That topped 78% of its large-cap growth peers, which averaged 29.96%. The S&P 500 was up 29.12%.

Over the past three years the fund's average annual gain is 18.14% vs. 15.70% for its peer group and 17.73% for the big-cap bogey.

Caruso, age 57, discussed his investment process with IBD from his office in Manhattan.

IBD: How does your search for leading stocks differ from other growth investors'?

Caruso: We think of equities generally (in terms of) a combination of growth and capital returns in the form of dividends and share buybacks, which support the valuations of equities over a long period.

And we take a long-duration approach to investment opportunities. But most growth investors are dangerously focused on the moment, growth in the short term. We try to exploit this phenomenon where not a lot of analytical work is being done four to five years out.

IBD: Give me some examples that show how your tack works, please.

Caruso: In the spring of 2012,Chipotle Mexican Grill ( CMG ) missed a couple of months of sales estimates and the stock was crushed. It went from about 440 to 230 a share. But our research let us be marginal buyers in that lurch. We were confident in the caliber of management. We bought a distressed stock in a great long-term franchise (between May and July 2012 between 380 and 400). Later, they began to execute and sales improved. (We added to our position) through the beginning of October 2012 at prices between 284 and 330.

IBD: IsCognizant Technology Solutions ( CTSH ) another example? You added a big chunk to your stake a few quarters ago.

Caruso: They have a great core competency in technologies that are increasingly desired by clients: in the cloud and in mobility. It's been growing in the high teens and low 20s for years. It has no debt, and it has excess cash.

After putting up a strong quarter, they got caught up in the immigration debate. They rely on a lot of foreign visas to conduct their business. The stock went down about 25% in a heartbeat.

That was an opportunity for us to reload. In the spring of 2012 we started initiating. The stock broke down into the high 50s (from 78). We met with Cognizant managers for three or four hours, and we left convinced they still had a great business and plan. The stock moved higher. The immigration debate percolated, and we bought in the 60s. Now it's in the 90s.

IBD: Are you looking for investment opportunities created by the prospect of the Federal Reserve tapering its bond buys?

Caruso: We don't try to overthink the macro environment. So our marching orders to our analysts are to focus on company fundamentals.

But when (Fed Chairman Ben) Bernanke started the tapering discussion, after having underperformed the broad market and value in particular the prior 12 to 15 months, growth securities started to do well. So the market response to tapering seems to have catalyzed a shift on the margin to growth stocks.

IBD: Is that because growth stocks tend to have more foreign exposure?

Caruso: Yes, growth stocks generally have a little more exposure to foreign earnings growth. And U.S. value stocks have more exposure to, let's say, earnings that are fueled by Federal Reserve stimulus steps. This is speculation on my part, but the discussion regarding tapering might auger well for future growth stock performance.

IBD: Computer services, software and systems are your largest category of holdings at 12.36% of assets. Why do you expect good things from them?

Caruso: Cognizant is one, with close to a 4% weighting. The portfolio is built around companies like that andGoogle ( GOOG ). We think ofPriceline ( PCLN ) as a service company. Some people think of it as a technology company.

Ansys ( ANSS ) is an engineering simulation software company. People think of this as a company that benefits from innovation.

In the old days, you had a team of engineers design a new product, build mockups, then software would run calculations that tested stress characteristics. It was on the tail end of the innovation. And it might take weeks to run those simulations.

Today you can run millions of simulations before you even get to the real engineering side of things.

IBD: Biotech is your second-largest industry group, with 5.45% of assets. Why are you focused there?

Caruso: Biotech came out of a very long, severe stock price underperformance. Now we're seeing far greater pipeline productivity emerging from a couple of leaders. We've centered our investments onCelgene (CELG),Biogen (BIIB) andGilead (GILD). Each is in a different area of disease management.

Biogen has been mostly a multiple sclerosis story. They've come to market with a new oral medicine called Tecfidera, which has experienced one of the most unbelievably successful product launches in pharmacology history. But (investors) have been so focused on MS that they haven't paid attention to some of the products that are in development.

There is a hemophilia product (Eloctate) that we expect to launch in mid-next year. It has the opportunity to take share fromBaxter (BAX) and drive growth. And there's upside left for Tecfidera for a long time to come.

Gilead is basically an HIV and hepatitis C story. It has new product launches on the horizon. We expect Gilead to remain dominant in HIV in the near- to midterm. Their hepatitis C portfolio is starting to contribute meaningfully to corporate growth.

Celgene is a multiple myeloma story, a cancer story. We see expanding use of the marketplace.

All of these companies were coming off of pretty conservative valuations for the kind of growth we envision them experiencing for the next couple of years.

IBD: Why did you trim yourFacebook (FB) stake recently? You could not have foreseen the pullback that began in mid-October.

Caruso: The stock had an amazing run after reporting Q2 earnings. They demonstrated great acceleration in their mobility business, which people got excited about. The stock doubled in a short time.

We made a meaningful reduction in exposure in that euphoria. It had become close to 3% of the portfolio. So we cut our position roughly in half. It is roughly 1.5% today.

Their 20% fall? The stock had gone up the day they reported earnings. Then management talked about the need to spend more on investing in people and their product. A lot of highly valued, high-growth companies have seen similar price corrections.

I'm comfortable owning the stock. At the right price, we're getting back in.

IBD: Michael Kors (KORS) is relatively new for you. Are you concerned that earnings-per-share growth has sharply decelerated in recent quarters?

Caruso: We're always concerned about decelerating growth rates. But Kors' decline is to a less-than-extraordinary level. That's still better than a lot of companies. The stock is reasonably valued for the kind of growth we envision. They have opportunities in Europe and elsewhere overseas. Kors is seen as differentiated here and overseas.

IBD: Any surprise toStarbucks' (SBUX) accelerating EPS growth?

Caruso: No. They're just an unbelievable company. They're one of the few that has been able to consistently reinvent themselves. They've done a brilliant job of expanding their product offerings in small footprint stores, in being first to market in using new technologies to connect to their customers and their rewards programs are best in their class.

IBD: Precision Castparts (PCP) is up this year, but you've done some trimming. What are your concerns?

Caruso: They are persistent in acquiring businesses that let them leverage their own infrastructure. And they're an important supplier toBoeing (BA) on the 787. They generate about $10 million of content on every 787 that Boeing ships. Part of our reduction is that we own both companies. If we sell, it probably will be out of Boeing. Precision has lagged Boeing, so Precision has more upside.

IBD: Intuitive Surgical (ISRG) is way down this year. Yet you've added to your position in some recent quarters. Are you still optimistic?

Caruso: This has been the most disappointing stock in the portfolio in 2013. The interest we had was centered on the uniqueness of their business. There are no competitors at their scale. Robotic surgery is here to stay and will continue to grow.

Procedure growth continues to expand at a midteen clip year over year. The issue with execution relates to installation sales, which has slowed, especially in the U.S.

We expect a couple more tough quarters. Procedure growth will continue in the 16% area. There's no competition. Unbelievably high margins, big share buyback, no debt. Hopefully, it will be a contrary growth stock that recovers.

IBD: Are you concerned thatLinkedIn's (LNKD) EPS growth has slowed for two quarters?

Caruso: They've brought a new (advertising product for mobile devices) to market. It will help their growth rate re-accelerate into next year. Like we did with Facebook, we made decent sales in the summer on the market euphoria around this stock. We're more interested in finding a price to re-engage LinkedIn than Facebook.

We think of it as a core holding, a business that's tough to replicate due to their network effect and LinkedIn managers who think of this as a business and want it to be profitable. It's a good business that is richly valued. It will grow into that. So getting the entry and trim points right is important.

IBD: Noble Energy's (NBL) EPS growth has soared the past two quarters. But tumbling crude oil prices have doused energy producer stocks' spark lately. This stock has pulled back about 10% since Oct. 30. Why stick with it?

Caruso: Noble is one of the best-positioned energy companies by way of its fracking inventory. Overseas -- in Israel and Africa -- they have unbelievable reserves. And they are really good operators, really focused on creating value.

Energy firms are more volatile than what we typically engage, but this company's assets are special.

We've seen a reduction in underlying commodity prices, so we would welcome an opportunity to buy some of this back, make it larger in the portfolio. It's not quite at a point where we would start buying it back.

IBD: What's the biggest change you've made since taking this fund's helm in February 2012?

Caruso: Basically, our perception of growth is linked to a company's ability to create long-term value. So our focus is further forward than many other investors' focus is. It's more on the economics of business and profitability than on the hunt for earnings growth, which is sometimes very episodic. We're still looking for opportunities in large-cap growth. But we're focused on the longer term.

IBD: What was the fund's prior time horizon?

Caruso: I can't say, but it was probably more consistent with most growth managers'. Annual turnover in growth portfolios is often 100% to 150%. We're trying to do closer to 50%. We want great franchises that have the ability to win over a very long time. I tell my analysts I want them to understand how companies are competitively differentiated. I don't want them spending their time trying to anticipate when a bad business is a good stock.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Mutual Funds

Referenced Stocks: ANSS , CMG , CTSH , GOOG , PCLN

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