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Stock-Picking Secrets from a Fund Legend

Ron Baron, chairman, CEO and portfolio manager at Baron Capital, offers words of wisdom in an interview with Andrew Tanzer, Kiplinger's Personal Finance.

Q: You’re a master of growth investing, which involves finding companies with prospects for faster-than average profit growth, among other measures. What do you look for?

A: Everyone can understand what a growth company is. What is hard for most people is being able to understand competitive advantage – the most important thing. You need to understand a business, how it operates and what makes it difficult for others to compete. It may have a license, patents or a head start in technology. We make investments on the basis of what we think a business will be worth in five or 10 years as opposed to what it’s worth right now. Our goal has been to double our money about every five or six years.

Q: What do you emphasize to your portfolio managers and analysts?

A: I tell them two things are critical. Number one is competitive advantage. Number two is management, the people who run the businesses. Those executives must be talented, really smart, great leaders, hardworking, inspirational and possess vision. The other thing – which is probably more important than anything else – is whether you can trust the individuals.

Q: What stocks do you like now?

A: We like Hyatt Hotels (H). It has made terrific deals to manage all-inclusive resorts while selling real estate to reduce its fixed assets. Vail Resorts (MTN) is becoming a subscription business, with most revenues coming from season-pass sales in advance of ski season. Real estate company CoStar Group (CSGP) is investing in digital residential real estate services. MSCI (MSCI) is a unique index provider with strength in environmental, social and governance risk metrics.

Q: When and why do you sell stocks?

A: We sell principally for three reasons. First, if an investment becomes very successful and, as a result, represents too large a percentage of diversified portfolios, we gradually reduce holdings. Second, the return that we require – our “hurdle rate” – in most instances is a potential double in five or six years. We believe that most of the time we can accomplish that return by investing in businesses that can increase profits, cash flow and other drivers of value by 15% per year. If a company’s growth rate slows to 7% to 8% per year as it matures, it becomes a candidate for sale. Finally, if we determine we have made a mistake, we sell as quickly as humanly possible.

Q: Do you spend any time looking at interest rates, forecasts for gross domestic product and other macroeconomic indicators?

A: Macro judgments are not an important part of our process. I can’t predict when there’s going to be a recession, and I believe neither can anyone else. I can’t predict when the market’s going to go up and neither can anyone else.

One thing we are certain about is inflation. Inflation is a big deal and always has been. We invest in growth stocks to hedge against the decline in the purchasing power of our money and to participate in the growth of our country’s economy. Inflation will be higher sometimes, lower sometimes, but it’s always going to be there.

Editor’s Note: Andrew Tanzer is a contributing writer at Kiplinger’s Personal Finance magazine,

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