Deep Dive: A strategy of buying ‘the fastest-growing businesses in America’ has paid off for this investor in 2020
Gerald Sparrow screens companies for ‘pure units’ of sales to pick winners
Gerald Sparrow manages one of the smallest mutual funds, the $26 million Sparrow Growth Fund. This year he’s beaten better-known funds as his strategy of buying what he calls “the fastest-growing businesses in America” has paid off.
Sparrow oversees about $165 million at Sparrow Capital Management in St. Louis, which he founded in 1998. You can see charts, below, that show the Sparrow Growth Fund’s
excellent performance against benchmarks. So far this year it’s up 6.8%, ranking the fund in the top 2% of its peers, according to fund-research firm Morningstar.
The mutual fund manager screens for companies that grow revenue rapidly and refines the results by focusing on unit sales growth. For example, a biotechnology company’s revenue may spike in one particular quarter because of a large research payment from another company. So Sparrow digs into company filings to make sure that rapid sales growth in dollars is derived from the sale of what he calls “pure units.”
Sparrow, in an interview April 27, explained that he had changed his strategy for managing the fund after 2016 to “get the emotion out of investing.” That means he isn’t selecting stocks by sector, industry or business trend, and if a company’s unit sales slow significantly, relative to other companies, he will dump the stock.
When adding a company to the portfolio, Sparrow takes a position that makes up about 1% of the fund’s assets. This strict criteria means the fund has 100 stocks.
So the top holdings, shown below, are those that have performed well since they were purchased. The fund invests in companies of any size, though Sparrow said the average market capitalization range is $5 billion to $7 billion, in the mid-cap range.
An example of a large holding he discussed in the interview is Carvana
an online platform for buying and selling used cars. This might seem like a bad play during the coronavirus lockdown, but the longer-term trend toward online transactions has supported the company’s business model.
Carvana’s stock is down 8% this year. Sparrow said: “We did sell one of our car-related businesses last quarter, because the growth wasn’t there.”
He hasn’t sold Carvana, though he will if he sees “a drop off in their business, relative to other choices.”
In 2019, Carvana’s retail units sold increased 89% to 177,549, and revenue doubled to $3.94 billion. The company is scheduled to release first-quarter results May 6.
Fast-growing companies are prioritized in the fund, though he says he “will not sell a winner.”
“We don’t use technical analysis and we do not trade on volatility in the market,” he added.
Here are the fund’s 10 largest holdings as of Feb. 29:
|Company||Ticker||Share of portfolio||Total return – 2020|
|RingCentral Inc. Class A||US:RNG||2.8%||34%|
|Shopify Inc. Class A||US:SHOP||2.6%||61%|
|Tandem Diabetes Care Inc.||US:TNDM||2.5%||25%|
|Trade Desk Inc. Class A||US:TTD||2.4%||13%|
|Carvana Co. Class A||US:CVNA||2.2%||-8%|
|Alteryx Inc. Class A||US:AYX||2.1%||13%|
|Acceleron Pharma Inc.||US:XLRN||2.0%||75%|
|Coupa Software Inc.||US:COUP||2.0%||15%|
|Okta Inc. Class A||US:OKTA||2.0%||30%|
The Sparrow Growth Fund is rated three stars (out of five) by Morningstar. For three years, it has a four-star rating within the financial research firm’s “U.S. Fund Mid-Cap Growth” category.
Here’s a comparison of the fund’s performance (after expenses, which are considered high at 1.60% of assets annually) to its Morningstar fund category, the S&P 400 Mid-Cap Index
the S&P 500 Index
and the iShares Russell Mid-Cap Growth ETF
for periods through April 29:
|Total return – 2020||Average return – 3 years||Average return – 5 years||Average return – 10 years||Average return – 15 years|
|Sparrow Growth Fund
|Morningstar U.S. Fund Mid-Cap Growth category||-7.2%||9.6%||7.6%||10.6%||9.3%|
|S&P 400 Mid-Cap Index||-17.2%||1.0%||4.0%||9.0%||8.4%|
|S&P 500 Index||-8.5%||9.4%||9.1%||11.6%||8.7%|
|iShares Russell Mid-Cap Growth ETF
|Sources: Morningstar, FactSet|
Scroll the table to see all the data.
Sparrow said the S&P 400 Mid-Cap Index didn’t make for a useful comparison to the fund’s performance because of its relatively high weighting in beleaguered or slower-growing sectors and industries, including energy, banks, restaurants and airlines.
To illustrate the fund’s success since Sparrow’s change in strategy, here’s a total return comparison from the end of 2016 through April 29, 2020: