High-upside stock picks, investing strategy from top-ranked fund manager – Business Insider

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  • Jeff James is the lead portfolio manager of the $283.2 million Driehaus Micro Cap Growth fund and the $293.6 million Driehaus Small Cap Growth fund, which have returned 47% and 38% this year, respectively.
  • The 30-year investing veteran shared a micro-cap stock that has surged more than 1,000% so far in 2020, and another under-the-radar stock that he believes will have similarly “dramatic upside.” 
  • James also laid out three COVID-induced small- and mid-cap opportunities in the technology sector. 
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The run-up in US mega-cap growth stocks this year has given active managers plenty of opportunities to shine. But Jeff James is not experiencing any fear of missing out. 

James is the lead portfolio manager on the $283.2 million Driehaus Micro Cap Growth fund and the $293.6 million Driehaus Small Cap Growth fund, which have returned 47% and 38% year-to-date, respectively. That’s helped them both handily beating their benchmark indices and category peers, according to Morningstar data. 

It’s also marked a degree of outpeformance versus the tech-heavy Nasdaq Composite index, which has risen 33% in 2020.

James’ track record at the $10.2 billion Chicago-based Driehaus Capital Management is so compelling that the firm — founded in 1982 by famed momentum investor Richard Driehaus — launched another fund focused on small- and mid-cap stocks for him in May this year. 

“It’s really about the inefficiency and the discovery process and starting off with a smaller base,” he said of his focus on micro- and smid-cap stocks.

“The stocks that perform the best on a percentage basis and return basis over time are usually the ones that are starting off of the lower base and ones that are less discovered,” James added.

James’ investment philosophy and process

During his 23-year tenure at Driehaus, James has deployed the same investment philosophy to locating hidden gems with the potential to deliver exponential returns. 

“It’s focused on earnings growth and companies that are outperforming fundamentally where they’re going to have positive earnings surprises and upward estimate revisions,” he said. “We also look at companies that have differentiation from a product or market position standpoint, and ones that are well managed.”

While James’ philosophy is straightforward, it takes consistent efforts to implement it in the team’s investment process. 

“It’s looking at earnings surprises and reference statistics to see if companies are improving and having positive revisions,” he said.

James continued: “It’s also meeting with companies all the time before COVID and now we’re doing it all over Zoom. But we’re interviewing management teams and really trying to figure out what companies are differentiated, which ones are beginning to outperform, and if that dynamic is sustainable.”

The stock that has skyrocketed more than 1,000% this year 

One stock that distinctively illustrates James’ stock-picking skills is tech-driven fitness company Nautilus (NLS).

The company, which was essentially distressed and trading at less than $2 a share in mid-March, has gone up  1,155% this year and was trading at roughly $22 per share on Tuesday.

“It’s really the theme of people exercising away from the gyms and in their homes,” he said of the catalyst behind Nautilus’ spike.

“They’ve seen a huge surge in demand for their products and so they’ve come out with a number of new products over the past several quarters. But it has really been a shift in their actual demand that’s led the way.”

The sudden surge in demand came in June when Nautilus’ sales spiked almost 94%, a sharp reversal compared to its 2% sales decline in 2018, and a 22% plunge in sales in 2019, James explained. 

“So it’s really benefited from the whole trend of people working from home and buying equipment to work out at home,” he said, adding that the company was smart to capitalize on the trend by introducing a Peloton-like indoor exercise bike and other at-home fitness equipment. 

It will be hard to find another stock like Nautilus, James admitted, but he has been watching Inphi (IPHI), another under-the-radar stock that could rise higher. 

“This is a semiconductor company that we’ve owned for quite some time,” he said. “They’re focused on companies that provide for bandwidth solutions within data centers, so Inphi is really seeing an acceleration in revenues and earnings.”

He continued: “And it’s really benefiting from the increased demand that is occurring because of the increased consumption of data and the need for broadband. So a lot of that broadband consumption goes through data centers and Inphi is really a leading provider of chips into data centers.”

The stock, which has gone up almost 70% this year, will have a “dramatic upside over time through continued market expansion and design wins,” James said.

COVID-induced tech opportunities 

With an eye for innovative companies, James believes that COVID-19 has created “an environment of haves and have nots” where the tech sector has singularly benefited from the accelerated digital transformation as a result of the pandemic lockdown. 

However, FAANG stocks are not the only ones to have reaped the benefits. One of their smaller tech brethren that James likes is Teladoc Health (TDOC), which is up roughly 180% year-to-date. 

“Teladoc is a tech stock with a healthcare frame,” he said. “They are the leader in telemedicine and they went from being a company that very few had heard of to really being a widely-known name right now.”

Another COVID-propelled stock is DocuSign (DOCU), which has run up 223% this year so far. 

“DocuSign offers electronic signing of documents and in Zoom, which we also owned early on until it became too large for us,” he said. “We think it could be ubiquitous just like Zoom.”

He also likes Bandwidth (BAND), a cloud-based communications services company whose stock has shot up 205% this year. 

“They provide a lot of the IP-based network for a lot of these services such as Zoom or Cisco’s Webex. Those calls are conducted with Bandwidth being behind the scenes,” he said. “So there’s a lot of high growth companies that use Bandwidth as a vendor.”

Innovation and Patience 

From economic uncertainties to election volatility, there are a lot of cross-currents in the market, but James believes that it’s best for investors to stay invested. 

“Oftentimes, investors will sell prematurely because of some volatility when the markets are just pulling back or riding out some turbulence because of some market noise,” he said. “But over time economic growth and innovation historically have driven the market higher so it’s important for investors to be in the market.”

But the point is to not just have market exposure but also to pick companies that can break new ground.

James concluded: “The best thing for investors is to pick innovative companies that have the characteristics to perform, to do the research on individual stocks, to be diversified, and to have the patience to stick through any volatility.”

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