Three resilient growth shares the market underestimates

James Thomson, manager of Rathbone Global Opportunities fund, explains how he finds innovative and scalable businesses that are growing fast and shaking up their respective industries. Thomson names three companies that he thinks will become household names in the coming years. He also names a couple of examples of recession-resistant businesses, which comprise 15% to 25% of the fund.

Kyle Caldwell, collectives editor at interactive investor:Hello. Today I'm joined by James Thomson, fund manager of the Rathbone Global Opportunities fund. The fund invests mainly in shares in developed markets. So, James to start off with, could you explain why the fund mainly sticks to developed markets and does not invest in the Asia-Pacific or emerging market regions?

James Thomson, fund manager of Rathbone Global Opportunities: Yes, that's right. Well, the reason I stick to developed markets is because I don't think I have the skills or the expertise to credibly invest in emerging markets. I think it requires a lot of local knowledge when you're investing in Brazil, Russia, India or China. Actually, early in my career, I spent quite a lot of time in emerging markets, and I think it really sort of reinforced my view that I'm not smart enough or I don't have enough experience to do it. So I really think if you want exposure to those parts of the world, and that you should have some exposure, you should go to a dedicated emerging markets fund manager. My fund sticks to developed markets where I think I have a reasonable track record of success over 18 years now. 65% of the fund is in the US, 25% of the fund is in Europe and the rest is in the UK.

Kyle Caldwell:The fund looks for innovative and scalable businesses that are growing fast and shaking up their respective industries. So what are the key ingredients that you're looking for in a business to find a potential winner?

James Thomson: Well, this is a growth fund. And when I started running money in 2003, I didn't like the idea of investing in businesses that were damaged, or unpredictable, highly reliant on variables outside of their control and really their only quality being that the stocks look cheap. So I was always willing to pay a higher price for quality, resilience, innovation and scalability. And usually, the only criticism that these businesses faced, was that they'd already found success and so that all the good news was in the price. But usually I think what other investors underestimate is the potential size of the addressable market being larger than people expect. And often these companies use their business as a platform to grow into adjacent areas.

Amazon (NASDAQ:AMZN) is a good example. I mean, Amazon started life selling books, and obviously they achieved success doing that in a market capitalisation that reflected that success. But of course, they used that as a springboard or a platform to go into different areas of e-commerce and then go to different areas of cloud computing and different adjacencies after that. Online grocery, healthcare or actually, ironically, now moving into brick and mortar retail. So really, it's trying to take advantage of where those markets are larger than investors anticipate and where these businesses are using them as a platform.

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Kyle Caldwell: You aim to invest in companies before they become household names. In the top 10, there are a number of familiar names, including Alphabet (NASDAQ:GOOGL), Amazon and Microsoft (NASDAQ:MSFT). When did you first invest in each and why do you still own all those three today?

James Thomson: Yes, we've owned Microsoft and Alphabet for four or five years. We've owned Amazon for more than 10 years. But I think even 10 years ago, Amazon was a household name. But investors and particularly professional fund managers hated it, hated it for the heavy investments that depressed profitability. Hated it because they didn't follow the Wall Street cookie cutter of holding our hands and spoon-feeding us with the future strategy with precision. You know, I really think the growth potential for all of these businesses was underestimated and the addressable market was a lot larger than people thought. So we still own these businesses.

I think they are mission critical, gold standard growth companies. And if you just look at Microsoft. You know, this is now an indelible part of our corporate and personal IT. And yet IT spending for most businesses still represents less than 3% of revenues. The digital transformation that all of our companies are going through is very real, and it ends up becoming an arms race where you are constantly trying to be at the leading edge for your employees and your customers, and that will benefit businesses like Microsoft, Alphabet and Amazon, I think, for many years.

Kyle Caldwell:Could you run through a couple of stock examples of companies that are not at the moment household names but in a couple of years' time have the potential to be?

James Thomson: Well, that's an interesting question. Actually at Rathbones every year we have a Christmas quiz and we're asked to pick the single stock we think will be the best performer over the next year. In 20 years, I haven't won that competition once, which is pretty embarrassing, but I think what it shows you is actually picking single stocks is hard. But building a portfolio gives you so many more shots on goal. So with the risk of being wrong in the short term, I'll give you a few potential companies that could become household names. I think the first one is Fevertree Drinks (LSE:FEVR). Fevertree is a business that is a household name in the UK, but not in the US, and that's the market that they're tackling now, and I think it could be in a few years. But I don't think it will be with a tonic strategy. Americans don't drink nearly as much gin as they should, and so I think if Fevertree is successful in the US market it will come on the back of drinks such as ginger ale, ginger beer, pink grapefruit and flavoured sodas. I think that potentially is the success factor for Fevertree in the US. 

Another business, Essilorluxottica (EURONEXT:EL). Luxottica has made almost every pair of sunglasses you've ever owned. Ray-Ban, Oakley, Armani, Prada, Versace, Dolce and Gabbana, all under the brand of these luxury goods companies, but all produced and designed by Luxottica. Essilor is the largest lenses company in the world, and the combination is obvious, but I think compelling. We're in a world of a rapidly ageing population who spend a lot of time staring at screens. And so I think there's probably a pandemic of poor vision brewing that needs to be addressed. And I think this is an exciting business. It's a great combination of vanity and vision.

And then the final business is a US business called CoStar (NASDAQ:CSGP), and this is certainly not a household name. But it is a US property giant, but they don't own any property. They own data. Data on almost every commercial property in the developed world. It's the Bloomberg of commercial property data, except the difference is that there's no alternative. There is no Reuters, there's no FactSet, there's no Refinitiv. There's one golden source of data that every customer needs. And they also have a residential business that looks a lot, a lot like a baby Rightmove. So I think the growth, the resilience and the domination of these businesses has been underclubbed by the market, and so they potentially could become very successful in the future.

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Kyle Caldwell: A part of the portfolio is invested in recession-resistant shares. Could you run through a couple of examples? And what is the current allocation to that part of the portfolio at the moment?

James Thomson: We allocate anywhere between 15-25% of the fund in what I call these sort of weatherproof, recession-resistant businesses, and that actually was a direct reaction to dreadful performance that I had in 2008. I came out of that year and I said, I'll have to get better as a fund manager, I need more balance and diversity in this fund to protect against these dislocations. At the moment we have about 20% of the fund in this weatherproof bucket, this defensive part of the portfolio, and I'll give you a couple of examples.

One is a company that collects garbage, Waste Connections (NYSE:WCN), a US business. In the US, you actually pay for your garbage collection, and things have to get pretty bad for you to turn off that service. And, you know, even if you're consuming less in a recession, which is not really in the American ethos, but whether your bin is full or your bin is three-quarters full, sadly, you pay the same. And actually for this business in many markets, they're granted monopolies or de facto monopolies, as these garbage companies actually own the landfill sites. So I think that's a good sort of defensive business to own in the portfolio, and it doesn't tend to do well in a booming economy, but provides us with a buffer during more difficult times.

And then another US business I'd point to is Costco (NASDAQ:COST), which is the wholesale members club. Now, of course, this is a retail business, and at first blush, you'd think that might be vulnerable during periods of economic dislocation. But actually, I think it's highly recession-resistant by virtue of its low prices and staple like items that they sell. It's actually the only retailer in the world I've ever heard of that has a ceiling on their mark-up. Normally, retailers try and achieve as much mark-up as possible, but reportedly Costco has a 15% mark-up limit. And then when you combine that with the scale and the buying power that Costco has, it means that even in an inflationary environment where we are now, I think their value and quality will become even more compelling.

Kyle Caldwell:James, thank you very much for your time today.

James Thomson: Great pleasure, Kyle, thank you.