Fast-growth firms key to Pilgrim's success

Mutual funds


Halloween spooked some investors in American Oncology Resources, which provides management services for physician practices. After disappointing Wall Street with somewhat lower-than-expected earnings, the company watched its stock fall 28 percent on Oct. 31, to close at $35.

Among the sellers was Gary L. Pilgrim, manager of the the no-load PBHG Growth fund, with $1.73 billion in assets. High-flying stocks, showing rapid earnings growth, are his specialty. But he avoids becoming too attached to any stock.

"We own a lot of stocks, and we don't have huge positions in any, because we believe accidents happen, and American Oncology is a typical accident," he said. "A worse-than-expected quarter is usually the first of a series of sad reports. Staying with them is a ticket to the poorhouse."

His refusal to ride a stock down has combined with an aggressive investing approach to produce an average gain of 22.3 percent a year since the fund began in 1985.

The fund's peers, in the small-company growth category, have gained 13.3 percent a year in the same period, according to Morningstar Inc.

Shaking off concerns about the over-all stock market, Mr. Pilgrim remains fully invested at all times. Some money managers look for promising industries and then the best companies in those fields. Others focus on segments of the market poised to soar at the next stage in the economic cycle.

Mr. Pilgrim's investing approach, however, relies heavily on a company's momentum, in both stock price and fundamental factors, such as revenue and earnings.

His computer identifies the 900 fastest-growing companies in the nation. Of those, PBHG Growth will take positions in about 90 companies with a market capitalization of less than $1 billion.

Some other PBHG funds will wind up with a stake in similar companies of other sizes. Only the smallest companies, with less than $250 million, go into PBHG Emerging Growth, which Mr. Pilgrim manages with Christine M. Baxter.

Neither of these growth funds is open to new investors. New investors are welcome, however, at PBHG Large Cap Growth. All the PBHG funds are products of Pilgrim Baxter & Associates of Wayne, Pa., which manages $6.5 billion and was acquired this year by United Asset Management.

What specifically does Mr. Pilgrim look for? Companies with little debt, high profitability and sustainable revenue and earnings growth of 30 percent or more. "We want superior companies that are doing something unique and dominant in the areas they operate in," he said. "These are the highest quality fast-growth companies in the marketplace."

Companies with a growth rate three times the market average do not come cheap. Therefore, the price-to-earnings multiples of the stocks in his fund's portfolio are much higher than the market average.

The average price of his stocks is nearly 25 times the earnings that he forecasts for the companies in the coming year, compared with roughly 16 times for the market overall. That makes for an unusually risky batch.

"We choose to take that risk in the interest of earning excess returns," he said.

High growth seems to be synonymous with high technology these days. PBHG Growth has about 40 percent of its assets in that sector.

"I guess I look kind of wimpy compared to managers who are strutting around with 60 percent or 70 percent weightings in technology," Mr. Pilgrim said, "but our growth fund is very diversified." Health-care and consumer stocks each account for 20 percent of the portfolio, and service companies represent 15 percent.

Before adding companies to the portfolio, Mr. Pilgrim and his six staff members do extensive research, often visiting company managers.

The fund buys roughly equal dollar amounts of every stock, so the shares that become overweighted in the portfolio have outperformed the others.

American Oncology, which made its first public offering of stock over the summer, disappointed Wall Street when it reported quarterly profits last week of 20 cents a share. That was 3 cents shy of what Mr. Pilgrim had expected. The company said some contracts had been delayed, but it also alluded to higher investment costs ahead, meaning earnings estimates had to be revised downward, Mr. Pilgrim said.

So he sold at what he termed a small loss. A devotion to companies that are doing well and a willingness to cut losses has a tax advantage for fund shareholders. Despite a 41 percent percent run-up in net asset value this year, PBHG Growth will not distribute capital gains to shareholders, because it has realized losses rather than gains.

Shares in Ascend Communications adjusted for splits, have risen from about $5 to $68 a share in the last 18 months, making it the largest holding in the PBHG Growth portfolio.

The company provides switching equipment to corporations and others offering access to the Internet. As such, Ascend is one of the few companies associated with the information technology boom already making money.

"Earnings were up roughly 200 percent in the most recent quarter," Mr. Pilgrim said. "They have little competition, and their area is the hottest in technology today."

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