Fear of failure drives many mutual fund managers to spread their bets widely. Actively managed U.S. stock funds hold an average of 152 different companies, reports Morningstar. World funds average 225.
The stewards of the funds on the following pages are different. They invest in 50 companies or fewer, following their best ideas with conviction—and to great success. Each fund's five-year return has beaten those of more than half of the funds investing in similar stocks. For the three funds that are at least a decade old, the same is true of their 10-year returns. Follow the managers' advice and you may prosper too.
The Pros: Mark Ashton, Prabha Carpenter, and Gregory Halter
Homestead Value Fund (HOVLX) has returned an average of 12.6% a year over five years and 7.0% a year over 10.
The managers: Mark Ashton, at the helm since 1999; Prabha Carpenter, who joined the fund in 2002; and Gregory Halter, who started in 2014, see themselves as long-term partners of the companies in which they invest.
The strategy: The trio stick to stocks of large firms selling at a discount to the value of the underlying businesses. They also screen for earnings growth rates in the high single digits or better, ample cash flow, and top brass who they believe use resources wisely.
One area the Homestead team likes is pharmaceuticals, which make up five of the fund's 49 current holdings. Big drug companies, says Carpenter, are rolling out new medicines but are not as expensive as their biotech peers. The managers' instincts have often been correct. Homestead Value ranks in the top 20% of its category for one-, three-, five-, and 10-year returns.
Next: Ashton, Carpenter, and Halter's three stock picks
P/E RATIO: 13.4
Why Ashton, Carpenter, and Halter like it: In recent years big pharmaceutical firms have been hurt by patent expirations of popular prescription drugs. But Carpenter says Pfizer is replenishing its portfolio with smart acquisitions, like its intended merger with global pharma company Allergan. Pfizer could face political fallout for its plans to move to Ireland for a lower tax rate. But if the merger goes through, the company will have more than 100 medications in mid- to late-stage development. Pfizer's forward price/earnings ratio is just 13.4, vs. the average 16.6 for large drug companies. And the stock has an attractive dividend yield of 3.8%.
Bank of America
P/E RATIO: 10.3
Why Ashton, Carpenter, and Halter like it: Bank of America has been digging itself out from under the housing market mess—and making progress. In the third quarter of 2014 the bank set aside $16 billion for litigation expenses related to the financial crisis. One year later the bank needed less than $1 billion to cover such costs. Meanwhile, demand for its products is growing. From July to September, mortgages and home-equity-loan originations expanded 13% from the year before, to $16.8 billion. And noninterest income rose 2%, to $11.2 billion. The stock trades at just one times Bank of America's tangible book value (assets that would remain if the bank had to liquidate). Says Carpenter, "That's a very reasonable valuation."
P/E RATIO: 15.5
Why Ashton, Carpenter, and Halter like it: For earnings growth and good valuations, Carpenter says she and her co-managers "love the industrials," especially Honeywell, which makes everything from home-security systems to airline parts. CEO David Cote says he wants Honeywell to be the Apple of industrials, and in 2014 the company launched an initiative to make products, like the Lyric smart thermostat, attractive and easy to use. The efforts are paying off: Analysts expect Honeywell's 2016 earnings to hit $6.58 a share, up 7.9%. At the same time, the stock trades below the S&P 500's P/E of 17.4.
The Pros: Bill Nygren and David Herro
Oakmark Global Select Fund (OAKWX) has returned an average of 10.4% a year over five years.
The managers: To make their selections, Bill Nygren and David Herro look for stocks selling at a steep discount to the price they believe a buyer expecting a reasonable return would pay for the company.
The strategy: Nygren and Herro also screen for firms that have a combined earnings growth rate and dividend yield that's at least equal to the market's average (about 7% today) and management teams focused on per-share growth. Free to invest in thousands of companies worldwide, the fund has remarkably few holdings at any given time: about 20 stocks. It is currently invested about 40% in the U.S. and 60% abroad.
Oakmark Global Select has beaten two-thirds or more of its peers in seven of the past nine years (it launched in 2006).
Next: Nygren and Herro's three stock picks
American International Group
P/E RATIO: 11.6
Why Nygren and Herro like it: Since AIG's 2008 government bailout, the global insurer has shifted priorities. In place of growth at any cost, AIG is getting leaner. In October, for example, it said it was pulling back in Central America and Japan. The trimming, says Nygren, should improve the company's return on equity (a measure of profitability).
AIG's stock trades at an inexpensive 75% of book value (a company's net worth). As the legacy of AIG's bad business continues to fade, Nygren says earnings will improve. In fact, analysts estimate that profits will jump 19.5% in 2016.
P/E RATIO: 9.8
Why Nygren and Herro like it: Volkswagen's emissions scandal and slow growth in emerging markets weighed on stocks of auto companies in 2015. But Nygren says that Germany's Daimler is resilient. Third-quarter sales of its Mercedes-Benz cars rose 18% from the year before, thanks in part to strong U.S. demand. And cost cutting helps: From January through September, earnings per share rose 13% year over year.
P/E RATIO: 14.6
Why Nygren and Herro like it: Nygren likes the oft-overlooked TE Connectivity, which makes sensors and connectors used in cars, industrial products, and communication systems. In 2015, TE sold a subsidiary for $3 billion, earmarking almost all of that for stock buybacks to boost earnings per share.
And demand is rising. TE forecasts 2016 automotive sales up 3% to 5% (ignoring exchange rates).
The Pros: John Rogers and Timothy Fidler
Ariel Appreciation Fund (CAAPX) has returned an average of 11.3% a year over five years and 7.7% a year over 10.
The managers: John Rogers, in charge since 2002, and co-manager Timothy Fidler, who joined the fund in 2009, invest in the stocks of 25 to 45 midsize companies.
The strategy: To execute their winning formula, the managers buy when shares trade at a 40% discount to their estimate of a firm's private market value, or the price a business would fetch if put up for sale. And though the bull market hits its seventh anniversary in March, the two say they have no trouble finding bargains.
Industrials and energy are two sectors where the mood has been particularly gloomy—and where Rogers and Fidler are hunting.
The fund's five-year return beats those of more than 70% of its peers.
Next: Rogers and Fidler's three stock picks
P/E RATIO: 8.7
Why Rogers and Fidler like it: You need to believe in an oil-price rebound to invest in energy firms these days—but not so to buy this stock, say Rogers and Fidler. Bristow flies helicopters for the global offshore oil industry, taking workers to and from rigs. Clients have cut spending, but the company gets 60% of its contracts' value even if its helicopters don't fly. And Bristow is reducing its reliance on the energy market: It recently agreed to provide civilian search-and-rescue services for the U.K.
Analysts expect profits to rise 32% in the fiscal year ending March 2017, but Fidler says Bristow is already a deal: "The market value of their helicopter fleet alone is $50 per share."
P/E RATIO: 15.2
Why Rogers and Fidler like it: Shares in Kennametal, which makes small industrial parts like drill bits and blades, have fallen 65% since December 2013, a result of low commodity prices; of the firm's sales, 44% are to mining and energy firms. Kennametal was run inefficiently, says Fidler, operating too many factories. But under a new CEO, the company is slimming down.
The managers value the stock at $36—a conservative figure, says Rogers, given the potential for bigger profits, especially if industrial spending picks up.
KKR & Co.
P/E RATIO: 6.0
Why Rogers and Fidler like it: As money flows into alternative investments, KKR, a private equity firm with $98.7 billion in assets, can benefit. Investors worry that it's getting harder for KKR to find bargain companies to buy, but Rogers counters that it has diversified with international and real estate funds. It's also returning cash to shareholders. Last year, KKR (a master limited partnership whose dividend is called a distribution) said it would pay $0.16 per share quarterly starting at the end of 2015, for a current annual yield of 4.2%. Rogers says the stock is worth $30.
The Pro: Elizabeth Jones
Buffalo Large Cap (BUFEX) has returned an average of 12.3% a year over five years and 7.8% a year over 10.
The manager: Elizabeth Jones, who joined Buffalo Large Cap in 2007, buys stocks of large companies with strong growth potential.
The strategy: ,Jones screens for firms that are leaders in their markets and add value to customers' lives. She also favors companies that can generate impressive returns on their investments and build their business in North America, where she believes economic expansion is sound. And overarching everything are 26 long-term growth trends that guide all investment decisions at Buffalo Funds, from changing demographics to health care costs. Jones owns stocks of no more than 45 companies at a time.
The fund's five-year return beats those of 53% of its peers.
Next: Jones' three stock picks
P/E RATIO: 19.4
Why Jones like it: Online retailers threaten the business of department stores. But Jones says TJX, owner of off-price retailers such as T.J. Maxx and Marshalls, is well protected. "People like to buy name brands at a discount and in real time," she argues. Home products make up as much as a quarter of revenue, and TJX has benefited from the housing market recovery. Analysts forecast profit growth of 10% in 2016, compared with mid-single-digit growth at best for other department stores.
Chipotle Mexican Grill
P/E RATIO: 26.7
Why Jones like it: This chain's stock has fallen hard in recent months, a result of slower same-store sales growth and an E. coli outbreak. But Jones says people still want to eat healthy, and Chipotle, which touts organic ingredients and responsibly raised meats, feeds that demand.
As for growth, Chipotle could as much as double its store count in the U.S., says Bradley Angermeier, a Buffalo analyst. The impact of E. coli on sales will go away in a year at the latest, he thinks. Plus, the company is "just beginning to dip its toe overseas," he says. Its 22 restaurants outside the U.S. represent 1% of Chipotle's total locations.
P/E RATIO: 16.5
Why Jones like it: Last year this generic-drug maker revealed it had overstated 2014 revenue and pretax income by about $35 million—a discrepancy linked to drug-company acquisitions. Akorn's stock is down 30% since then. A new chief financial officer joined in October, but a corrected 2014 report won't arrive before March. That makes the stock a risk, but Jones notes that Akorn has not restated its cash balance—a better indication, she says, that its business is sound.
Akorn specializes in producing generic versions of hard-to-make drugs, and prospects are good. Last year, Akorn got the government okay to sell 11 new drugs, and the company has another 78 products awaiting approval. Analysts expect earnings to jump 20% in 2016.