Back in 2009, several months after the stock market began its long climb upward from what we now know was its post-financial-crisis nadir, Dan Chung told Barron’s that the bull market was just getting started. Time proved him right, and now, nine years later, he thinks the rally has more room to run.
Chung, CEO and chief investment officer of Fred Alger Management, isn’t blind to the worries that have kept investors up at night, such as trade, monetary policy, and the inevitable slowing of the economy. But, he argues, the forces that have lifted the market are far from spent. Tech giants like Apple (AAPL) are still producing strong earnings, while big macro themes—among them, increasing global travel and continued technological innovation outside the tech sector—still have room to run.
The firm has certainly taken advantage of the long bull market, and many of its funds are outperforming their peers. The Alger Capital Appreciation Focus fund (ALAFX) landed in the top 10% of funds in the large-growth category over the past five years, while the Alger Small Cap Focus fund (AOFCX) is the No. 2 performer year to date among its peers. The Alger Dynamic Opportunities fund (SPEDX) has returned 16.5% in the past year, more than twice the average for its Morningstar category.
Dan Chung's picks
|Microsoft||MSFT||A subscription model for its Office suite of products and major growth of Azure cloud underpin Microsoft's impressive growth.|
|Roper Technologies||ROP||Roper is using technology to make its customers more efficient...and win business.|
|Tandem Diabetes||TNDM||Poised to be a disruptor in the healthcare space, it's insulin pump is the iPod to Medtronic's CD player.|
|Puma||PMMAF||Puma is carving out its own niche in sportswear by tapping into new social-media trends.|
Chung was once a star analyst at Alger, and he is quick to share that success with his diverse team. His time as an analyst came during the dot-com boom and bust, so he knows a thing or two about what causes bull markets to rise and fall. While markets seesaw with the headlines, Chung remains focused on the forces driving the market higher and the individual stocks that will benefit. He spoke to Barron’s about why the tech boom is far from over, why Microsoft (MSFT) still has it, and how the internet is touching just about everything.
Q: You made your mark as a tech analyst during the go-go ’90s. What did that experience teach you about where we are in the tech boom?
A: One trend that is really clear to us is Internet 3.0. Internet 1.0 was the birth of the internet, the ’90s until the bust. Internet 2.0, postbust, was characterized by the fact that a lot of the companies and the technologies were not really ready for prime time. They were not mature enough or affordable enough or easy enough to use to really be powerful tools for customers. Internet 3.0 is the period we are in now. I think it’s between three and five years old. This is really about the products, the technologies, the ecosystem, the affordability, and digital business transformation. We’re still in the early innings of great growth. There’s a much better chance that the market is surprisingly higher over the next two years. Part of the reason is because Microsoft and Apple are not expensive stocks. They can carry the market a long way.
Q: Speaking of Microsoft, it’s a company that has transitioned from Internet 1.0 to 2.0 to 3.0. It’s also one of your largest holdings. What do you like in Microsoft?
A: Microsoft is in an incredible position, and the numbers are showing it. It is one of the few megacap companies that’s accelerating revenue and expanding margins. This is also a bit of a life-cycle change story. Microsoft was growing only 2% and 9% in 2016 and 2017. This year it is going to grow by 15%. That’s a gigantic acceleration. And at the same time, we estimate that its operating margin will expand from 30% to 35% by 2020. If you are impressed by $43 billion of operating income, it (also) has $55 billion-plus of cash, and even after all of the expenditures for the cloud, free cash flow is about $40 billion. It has a 30% free-cash-flow margin. For a company as big and as old as Microsoft, that’s an incredible thing.
Q: What’s driving that growth?
A: The traditional Office Windows suite of products is getting decoupled from the PC sales. They used to be tied at the hip, but now everything has moved to software as a subscription. Microsoft is indisputably a leading enterprise software provider to businesses of all sizes globally and this transition to a subscription model is very beneficial to them.
Q: But it can’t just be Office, can it?
A: The big growth driver that has led to Microsoft beating revenues by over a billion dollars in each of the past two quarters is the cloud business. Microsoft is clearly No. 2 behind Amazon.com (AMZN), but it is now growing over 80% a year, and (the cloud) is a gigantic opportunity that will drive the company for years. At around $100, the stock is trading at only about 20 times next year’s free cash flow, and Microsoft’s dividend is about 2%. Today, it is trading at about 25 times current earnings, and that’s high, but by the end of the 1990s it got to 40 or 50 times, and Internet 3.0 is probably going to be better for Microsoft than Internet 1.0. It has organic growth in one of the leading growth markets in the world. It has all of the characteristics of something that could return 30%-plus over the next couple of years.
Q: Are tech companies the only one’s benefiting from Internet 3.0?
A: Roper Technologies (ROP) highlights how Internet 3.0 has come alive across industries. Roper is an industrial with an incredible management team that focuses on cash return on investment as a discipline. It has niche businesses, which have strong free cash flows, and are often very software-like. Medical and scientific imaging is about 35% of sales; radio frequency technology is about 30%; industrial technology is about 20%; and the last business is energy systems, testing, and control of petroleum pipelines and power-generation systems.
Q: What do they have to do with the internet?
A: Internet 3.0 infuses every part of what they do. For example, its Neptune line is one of the leading water meters, and they are Wi-Fi connected, so no one has to get out of the van to read your water meter. Roper is aggressively making use of the Internet of Things with sensors built into devices that can provide feedback on problems, and offer predictive preventive maintenance. The market doesn’t really appreciate that in 2001 5% to 10% of Roper’s revenue was recurring revenue (and) as of two years ago, more than 50% of revenue was recurring. In addition, because it has been early to spot all of these opportunities to use technology and software for clients, about 50% of profits are basically coming from software. It’s a good example of how technology, Big Data, and even artificial intelligence are really working in the world.
Q: Roper has gained nearly 30% during the past 12 months, and has outperformed the S&P 500. Isn’t the good news already reflected in the stock?
A: The stock is currently trading at a price/earnings ratio of 20, basically in line with peers like Honeywell International (HON), Amtech Systems (ASYS), and Danaher (DHR). It should have a premium for the quality of the business model, particularly in that transformation to more recurring revenue and much more software use than other industrials. While it shouldn’t be valued as a software company, when we look at some of the hardcore software companies that service manufacturers, they have multiples of about 35. So just apply a low industrial 15 multiple, blend that with a 35 multiple for software, and Roper should be trading at 25 times rather than 20, even if it won’t necessarily get that expansion.
Health-care companies are also benefiting from the growth of the internet.
Q: Can you tell us how that’s helping Tandem Diabetes Care (TNDM), a maker of insulin pumps that you own?
A: Tandem is a company that had a near-death experience. It has one of the most advanced pumps, and while they may look simple, they are pretty complicated. So Tandem faced delays and questions about competitiveness, and when it might run out of cash. The pump is now approved, is working quite well, and has been well received. Tandem got its products sorted out; it got its finances sorted out, and it is benefiting also from Roche Holding (ROG.Switzerland) and Johnson & Johnson (JNJ) exiting the U.S. pump market. Tandem does have to prove it can be profitable, but our experience has shown that in small-caps, it is much more important that a company be in a healthy, growing market. Not to sound like a broken record, but what does that have to do with the internet?
Tandem has a partnership with DexCom (DXCM), a company we also are invested in, which makes a continuous glucose monitor. It measures levels continuously and signals to Tandem when it’s time to do an automatic insulin dosage. The device’s alerts don’t have to be just for the user; they can be for doctors, so hopefully all of that data will provide even better ways for managing diabetes, a huge problem in the U.S. and in the world. A Tandem device looks kind of like an iPod, compared with a CD player from the big competitor in this field, Medtronic (MDT), which has around 70% of the market. Tandem’s pump is 40% smaller and lighter, and its software and connectivity is a meaningful advantage. This is another example of how internet, mobile, and data are changing health care.
Q: And it’s changing how retail brands reach their customers, too, isn’t it?
A: Puma (PMMAF) hasn’t been cool for a long time, and it struggled when it was part of luxury retailer Kering (KER.France). Kering spun out Puma, and that will free up management to really innovate and invest in the business. Puma has an innovative marketing thread focusing also on what is really happening with sneakers, and it uses social-media celebrity influencers to boost its products, an approach that is actually fairly new. Nike (NKE) signs up big athletes and pays them a lot of money, but on social media it is a little bit behind. Puma’s not going to pay a lot of money to try to get a big sports star. Its margins had gotten down to 2.8% in 2015, but it’s targeting 10% by 2022. We see an opportunity here for 10% top-line growth and earnings growth of over 20%.
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