If you want to know the best stocks to buy, check out holdings by managers whose mutual fund is among the elite minority of actively run funds outscoring the broad market — by a lot.
And it's not a bad way to shop for a fund for the diversified portion of your portfolio.
The $2.2 billion Invesco Small Cap Value Fund (VSCAX) is outperforming the broad market so far this year. The fund is above break-even going into Wednesday, with a 0.49% gain vs. a 12.50% setback for the S&P 500 and an 8.43% pullback by the Russell 2000 Value Index.
Best Stocks To Buy
Lead manager Jonathan Edwards and manager Jonathan Mueller outperformed with a portfolio that includes holdings IBD readers will understand. The fund owned 83 holdings as of June 30. This week, one stock was a member of the IBD Leaderboard and of the IBD 50. Two additional holdings were part of the IBD 50, IBD's flagship screen of leading growth stocks that show strong relative price strength and top-notch fundamentals. And 13 stocks had IBD Composite Ratings of 90 or higher.
A Composite Rating of 90 means that a stock is in the top 10% of all stocks on a number of technical and fundamental factors, including both price performance and earnings. Especially in a volatile market, watch for stocks that have 90-plus Composite Ratings and are forming bases or are in follow-on buy areas. That way, you spot the best-positioned stocks before they start big price runs. Look up a stock's Composite Rating at IBD Stock Checkup.
Seeking Undervalued Winners
A key step in the fund's investment strategy is to find stocks it likes that are trading at a big, temporary discount to their intrinsic values. Edwards says he and fellow manager Jonathan Mueller can do that in up markets and down markets. The fund is "for a long-term investor that wants to save for retirement," Edwards said. "It is an excellent option. It is designed to outperform through a full market cycle. And we have a demonstrated history of doing that."
Both managers have been at the helm of this 23-year-old fund since mid-2010. The fund's average annual return is 12.36%, vs. 13.60% for the S&P 500 and 10.84% for the Russell 2000 Value over the 10 years going into Wednesday, according to Morningstar Direct. It is 11.22% vs. the S&P 500's 9.83% and the Russell 2000 Value's 9.13% over the past 20 years. "We like to buy stocks with a 50% upside potential over three years," Edwards said.
That's their formula for identifying the best stocks to buy.
Further, growth stocks face a key headwind. Rising interest rates will make it increasingly hard for growth stocks to grow earnings, Edwards says.
Rising Future Cash Flow
Invesco Small Cap Value does not make bets based solely on macroeconomic factors. But macro factors can boost a stock's prospects for future cash flow. If those prospects are not fully reflected in a stock's share price, the fund might consider it attractively undervalued. It could join Edwards and Mueller's pool of best stocks to buy.
That was the case with Parsons, a software provider for the defense, intelligence and critical infrastructure markets. Invesco Small Cap Value began to buy its current stake in the fourth quarter of 2020. The share price was in the mid-30s.
The stock has grown more attractive in light of geopolitical tensions. Parsons "was a business we liked in 2020," Edwards said. "It was asset-light. It had great returns on capital. And great free cash flow."
The business looks strong, he says. "And the business has a great record of gaining market share in new contracts. And we thought it had a terrific option if the U.S. infrastructure bill passed, which it did."
Meanwhile, the coronavirus pandemic created investor concerns over Parsons' labor issues. Shares fell into the mid-20s. The company resolved those fears. Now, "the company has a great backlog of business, great balance sheet and excellent free cash flow." Shares are trading near 43.
What Made Flex One Of The Best Stocks To Buy
Flex is a Singapore-based contract manufacturer of flexible circuits and printed circuit boards for computers.
Invesco Small Cap Value Fund first pegged Flex as one of the best stocks to buy in the fourth quarter of 2018. The fund began its stake when the stock was below 8 a share. The stock had fallen from 19 earlier that year. The company had announced that it was going to exit a large contract with Nike. "But that was a loss-making contract," Edwards said. "Therefore, we saw the exit as a big net positive. The market had overreacted. We saw excellent upside. Since then, management has executed well and margins have risen. We think there's more to go."
Edwards added: "This is a business we like. It's a leading player in its industry, and a trusted partner for its customers. They have a well-diversified mix of end markets."
Play On Geopolitical Tensions
Huntington Ingalls Industries is a builder of military ships. The company also maintains and modernizes ships already in service. Huntington Ingalls first looked like one of the best stocks to buy in spring 2022.
The fund began its position at a price around 200 soon after Russia's invasion of Ukraine in 2022. "I think a lot of people initially thought the Russian invasion of Ukraine would be resolved really quickly," Edwards said. "We thought there were longer-term implications with geopolitical challenges with both Russia and China. That provides a tailwind to the company's growth profile."
Edwards likes the company's revenue stability and visibility as well as its construction backlog. Also, its field has high barriers to entry by new rivals. Much of its work is secret and entails security clearances, which are hard to obtain.
Shares trade near 240 now. Edwards expects free cash flow to more than double in the next two years. "And management has committed to returning all of its free cash flow to investors through buybacks and dividends," he said. "So we think many investors may not appreciate the free-cash-flow inflection point."
Follow Paul Katzeff on Twitter at @IBD_PKatzeff for tips about retirement planning and actively managed funds that outperform.
