BOSTON (Reuters) - For good stock market bets, some top investors can’t be too bothered by details like corporate profits: instead, they pick companies run by their founders.
Four of the top six performing companies on Nasdaq over the past five years as of Oct. 29 are run by founders, including Bruce Cozadd’s No. 1 Jazz Pharmaceuticals plc (JAZZ.O) and Reed Hastings’ No. 6 NetFlix Inc. Jazz is up 2,426 percent and internet streaming company Netflix has gained 584 percent, according to an analysis of companies with market caps of $10 billion or more by FactSet Research Systems Inc.
In fact, one-third of the 50 top performing Nasdaq companies are run by founders, including Jeff Bezos’s Amazon.com Inc (AMZN.O) at No. 49, despite this year’s 24 percent decline. So while stock drops at founder-run darlings such as John Mackey’s Whole Foods Market Inc WFM.O, down 31 percent this year, and Jonathan Bush’s Athenahealth Inc (ATHN.O), down 9 percent, have raised questions about whether fund managers will lose patience with strategies that show little or no profit, several with long-term records of success say they won’t bail out.
Hedge fund manager Whitney Tilson’s Kase Capital made eight times its money by sticking with its big bet on Netflix even as other investors doubted the company.
“I gave Hastings a longer leash while others didn’t,” Tilson said. He liked how the company fixed its mistake of trying to separate its DVD-by mail business into a separate company and how Hastings concentrated on the business, ignoring Wall Street’s naysayers. It’s a strategy that Amazon’s CEO should deploy as well, he said.
“Bezos should tell all of his doubters to go jump in a lake and buy another stock,” Tilson said. “He has no tolerance for mediocrity and his team is filled with A-game players.”
Bezos is Exhibit A for challenging a Wall Street mindset that chases earnings-per-share estimates by the penny each quarter. And more chief executives are being encouraged to think like Bezos. One big supporter is BlackRock Inc (BLK.N) Chief Larry Fink, who has challenged executives to invest in their operations instead of spending money on stock buybacks.
Ted Zoller, director of the University of North Carolina’s Center for Entrepreneurial Studies, said that while companies run by professional CEOs are a good bet for the immediate future, a better longer-term bet is on founding managers.
Professional CEOs are “good at allocating capital in mature markets,” Zoller said. “But most times I’d bet on entrepreneur founders because they’re looking to own markets and win the war.”
Gavin Baker, who runs the $12 billion Fidelity OTC Portfolio (FOCPX.O), agrees. His fund is beating 98 percent of his peers this year with a 14.07 return from a portfolio stuffed with founder-run companies including Amazon, Google, Facebook and Athenahealth. The fund’s 5-year annualized return of 20.25 percent is also beating 98 percent of peers, according to Morningstar Inc.
“For founders, these companies are like one of their children,” Baker said, “It’s been blood, sweat and tears. Only a few executives can go from personally packing books in the middle of the night to running a large, global enterprise.”
Baker was referring to Bezos, whose company is generating operating cash flow that totaled nearly $6 billion during the 12 months that ended Sept. 30. In addition, Amazon has built the industry’s dominant e-commerce platform, but only has about 1 percent of the global market, Baker said.
“I look for companies that are at the epicenter of multi-decade sector trends,” Baker said. “It makes sense for Bezos to take a longer-term perspective given the size of the opportunity that still lies ahead of him and the strength of his competitor advantage.”
He said investors have to make the right calls on where companies are in their lifecycle. If founders can still hit home runs, they get more leeway. But if a company is operating in a more mature market, it makes sense for its leader to do more shareholder friendly moves, such as boosting the dividend or buying back stock.
Several fund managers said Apple Inc (AAPL.O) is an example of a company that’s crossing the bridge to being more mature and more shareholder friendly. That’s in sharp contrast to when late founder Steve Jobs’ go-for-broke mentality got him fired before he was brought back and resurrected the company.
Robert T. Lutts, President and Chief Investment Officer of Cabot Wealth Management outside of Boston, said he can accept volatility at Elon Musk’s Tesla Motors Inc (TSLA.O) because its share price is almost eight times higher than where he got in.
“With Tesla, that can go down 35 percent in some six-month periods because we owned it at $30 a share. Where you start is a big factor,” Lutts said. Tesla traded at $238.09 on Tuesday afternoon.
To be sure, this year’s woes at Amazon are weighing down the performance of a number of large-cap mutual funds. It’s one reason why Fidelity Contrafund’s (FCNTX.O) 7.66 percent advance this year is lagging the benchmark S&P 500 Index by 3.32 percentage points.
That has put Contrafund’s portfolio manager Will Danoff in the unfamiliar position of being a middle-of-the pack performer amongst his peers.
But Amazon remains a top holding in the $110 billion Fidelity Contrafund (FCNTX.O), which held a stake worth $1.5 billion at the end of September. Danoff, who wasn’t available for comment, recently made another big bet on a founder-run company: his fund held $287 million worth of Alibaba Group Holding Ltd (BABA.N) stock at the end of September. Run by founder Jack Ma, Alibaba is the top e-commerce company in China, the world’s most populated country.
Lewis Piantedosi, who runs Eaton Vance’s Large Cap Growth Fund (EALCX.O), said founders can stretch for growth but they can’t ignore how their stock is doing because they risk losing talented managers who get a heavy dose of stock-based pay.
“If the stock isn’t working you’re probably going to have some unhappy employees,” he said.
Writing by Tim McLaughlin; Reporting by Ross Kerber and Svea Herbst; Editing by Linda Stern and John Pickering