The portfolio managers of a small-cap growth fund that returned 104% to investors in the past year share 3 stocks that are set to surge as part of the reopening trade — and lay out how they identify long-term compounders

  • Tucker Walsh and Rayna Lesser Hannaway manage the Polen US Small Company Growth fund. 
  • Walsh and Lesser Hannaway break down the “flywheel criteria” they use to identify winning stocks.
  • They also share three long-term small-cap stock picks set to surge as part of the reopening trade. 
  • See more stories on Insider’s business page.

So far, small-cap stocks appear to be the biggest winners in the midst of the historic economic rebound.

The Russell 2000 had more than tripled the S&P 500 index’s 6.6% rise to gain 20.9% year-to-date as of Friday, trouncing the Dow’s 8.5% and Nasdaq’s 4.9% during the same period. 

One of the beneficiaries of such bullish investor expectations for small-cap stocks is the $123.1 million Polen US Small Company Growth fund, which generated a 103.8% one-year trailing annualized return, according to Morningstar data. 

“Certainly, a reopening will help a lot of companies. Smaller companies, in theory, can get a little bit more of an accelerated effect from that,” Tucker Walsh, head of the small-company growth team at Polen Capital, said in an interview. 

While Walsh and his co-manager Rayna Lesser Hannaway welcome the better near-term small-cap performance as a result of the rapid economic reopening, they are much more enthusiastic about the long-term growth of such companies.

“When you take into consideration the change in behavior that’s come about from COVID,” he said, “you now have the ability for smaller companies to scale even quicker as talent acquisition is a lot more available because people are hiring remotely a lot more easily.”

The pandemic-accelerated digital transformation has led to a redistribution of the enormous power held by big brands and tech giants to smaller companies — especially those that understand how to get their message directly out to the marketplace — to succeed on a more even playing field, according to Walsh.

The flywheel framework 

To identify long-term compounding opportunities, Walsh and Lesser Hannaway follow a five-part framework known to the team as their “flywheel.”

To be an eligible candidate for investment, a company must be uniquely positioned and have a repeatable sales process, robust business model, and effective management team while also investing for the future. 

Lesser Hannaway said the team uses the analogy of a flywheel to illustrate that each of the five criteria must be met in order to crank the gear and power a great investment.

“As the gears turn round and round, that drives the compounding. And the faster they move, the greater the speed of compounding,” she said. “But like a gear in a machine,  if one piece is missing or it’s broken, then basically the compounding stops or slows down.”

The quality of the company is paramount because the highly-concentrated portfolio only invests in around 30 rigorously selected stocks at a time. 

Once a company passes the test of the flywheel framework, then four members of Walsh’s team are tasked with a deep dive into the stock. Two members work on building an investment case, while the other two examine potential risks in the company. 

“We call those our green team and red teams. By working together, we actually think it provides us the ability to have opposing arguments without having the same person make those opposing arguments,” Walsh said. “And that’s really important so that we rely on our teammates to find both the positives and the potential pitfalls.”

3 long-term compounders for the reopening trade

Walsh and Lesser Hannaway have high convictions in their process and portfolio, with each of them having invested over $1 million of their personal assets in the fund, according to Morningstar. 

They share three stock picks that not only fit into the team’s flywheel framework but have also been surging as part of the reopening trade. 

Outdoor recreational products retailer Yeti (YETI), whose stock has jumped 212% in the past year, is one of the team’s top picks. 

The company, which is known for its premium coolers and drinkware, boasts a unique brand and a strong customer connection that give it a strong competitive advantage, Walsh said. 

“Going back in the early days, Yeti coolers were created to just be a better cooler for fishing enthusiasts. They then continued to expand the company into other areas and made it more of an outdoor company,” he added. “They’ve done such a great job with their digital campaign and word of mouth that there are people that aspire to be photographed with a Yeti over anything else.”

Yeti’s brand loyalty also drives its repeatable sales process. By pricing products at a premium, the company has been able to generate significant cash, which can be deployed to reinvest in the business, according to Walsh. 

On top of that, he adds that the company has evolved from conducting less than 30% of their business direct-to-consumer before the pandemic to north of 60% now, which shows that the management is working hard to transition the business to meet new demand. 

BlackLine (BL), which has gone up 113% in the past year, is another company primed for long-term compounding growth, according to the portfolio managers.

The enterprise software company differentiates itself by focusing on a “niche” billion-dollar potential market. By offering cloud-based services that help companies automate and control the entire financial close process, BlackLine has been growing at a pace of 20%. 

“We anticipate that that kind of pace can keep up for some time,” Walsh said. “And we think that there is a stronger set of demand that has now come with the realization that with COVID people can work remotely, and can close the books remotely, so BlackLine, in particular, is very interesting from that perspective.”

Fashion e-commerce company Revolve Group (RVLV), which has rocketed 403% in the past year, is perhaps the most poised to surge in the post-pandemic economy. 

Founded in 2003, the company, which focuses on women millennial customers, operates multiple websites with curated offerings and leverages its network of influencers to reach potential shoppers.

Lesser Hannaway sees the company function more like a technology company than a retailer in that everything it does is based on data. 

“Unlike a traditional retailer that would have physical buyers going to fashion designers and choosing what they want to include on the store floor for the next season,” she said, “Revolve has been making decisions based on millions of data points that they’re collecting from purchasing behavior and from searching behavior on their websites.”

As a savvy data user, Revolve is a clear beneficiary of the pandemic-induced digitization of the economy, but it is also set to benefit from the pent-up consumer demand in the post-pandemic economy. 

“A lot of the categories that they sell, especially dress wear or clothes that women would wear to go to parties, was under a lot of pressure during the pandemic when everyone was stuck at home,” Lesser Hannaway said. “But now, as the economy starts to reopen and people start to go to events, they’ll be buying dress wear again.”

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