How T. Rowe’s Larry Puglia Beat the S&P Over 28 Years
Larry Puglia, who has managed T. Rowe Price's Blue Chip Growth fund since 1993, plans to retire in October.
PHOTOGRAPH BY ALYSSA SCHUKAR FOR BARRON'S
After 30 years at T. Rowe Price—28 of which were spent at the helm of one of its flagship funds, T. Rowe Price Blue Chip Growth —famed stock picker Larry Puglia will retire this year.
Puglia, 60, has a remarkable record. His longevity alone makes him stand out: Of the 461 large growth funds in existence 20 years ago, only 133 are still around today—a 71% failure rate. Yet Puglia, who has run the fund (ticker: TRBCX) since its inception in 1993, has done more than survive. Through April 30, the $102 billion Blue Chip Growth had returned an annualized 12.2% during his tenure, versus the S&P 500’s 10.5%.
The fund is one of the biggest using an actively managed growth strategy, and it regularly takes large stakes in companies that Puglia is particularly enthusiastic about. It has some 130 holdings, but more than a third of its assets are in the top five: He is a longtime fan of Amazon.com (AMZN), which now represents 11% of assets. Other top holdings include Facebook (FB), Alphabet (GOOG), Microsoft (MSFT), and Apple (AAPL).
On Oct. 1, Puglia will hand the reins to associate manager Paul Greene, who has worked closely with him since January 2020. Prior to joining Blue Chip Growth, Greene ran the $12 billion T. Rowe Price Communications and Technology fund (PRMTX).
Ahead of his retirement, Puglia spoke with Barron’s about what contributed to his success, his outlook for the markets, and a few favorite stocks. An edited version of our conversation follows.
Barron’s: What led to your outperformance?
Larry Puglia: A few things. First, a focus on quality franchises with durable compounding of earnings and, especially, free cash flow.
Second, one of the frameworks we use to examine companies is [Harvard Business School Prof. Michael] Porter’s concept of sustainable competitive advantage. That framework—looking for an industry or company with high barriers to entry, low threat of substitute products, and with power vis-a-vis its suppliers or customers—really appealed to me and was utilized extensively.
Third, we had a focus on [corporate] management and how well they were allocating capital. Capital allocation is extraordinarily important, because if you’re investing in companies that have superior free cash flow, but management doesn’t know how to reinvest it wisely, it’s like a fast ship without a rudder; it will soon run aground.
And fourth, we developed some expertise in identifying disruptive technologies, and the companies that would use them to create very large markets and strong free cash flow.
Some of your biggest holdings use disruptive technologies. What’s another example?
Intuitive Surgical [ISRG], which has totally transformed surgery with its minimally invasive robotic platform, DaVinci. We bought Intuitive Surgical in 2008. It has been disrupting general surgery for well over a decade [its IPO was in 2000], but it really got momentum in the past six or seven years in broadening out its platform beyond its initial surgeries for hernias and the prostate. The digitization of many industries has been a key ingredient to disruption.
What’s the outlook for active management?
We’re cautiously optimistic. Active management tends to move in cycles. When there is a high correlation among stocks and industries, and a lot of momentum in the market, active management can really suffer. We also certainly respect the fact that indexing can be quite effective, and that passive approaches have outperformed most strategies. However, investors should not forget that indexing is a form of momentum investing. More and more dollars are pushed into index stocks as they outperform, and they become a larger component of the benchmark. With the Russell 1000 Growth index, price-to-book is the sole selecting criterion. The more expensive the stock gets on price-to-book, the more its representation increases in the benchmark. We have certainly seen instances where it was wise to be cautious and different from the benchmark.
What about the stock market worries you most right now?
We’ve certainly seen pockets of speculative activity in parts of the market. That concerns us. I don’t think the continued barrage of SPACs, or special purpose acquisition companies, and other offerings is especially healthy. History would say that when capital is so widely available, it generally results in certain stocks performing poorly over time. Periods in which the Fed is very accommodative, where the capital markets are extending or creating capital very broadly, and the IPO market is white-hot typically have led to periods of more challenging performance. And not just for the IPO companies, but for the broader market also. That gives us pause.
U.S. stocks have outperformed globally for a decade. Is that likely to continue?
The U.S. has a vaccination process that’s ahead of plan, versus many other countries, so it’s been wise to have a meaningful bet in the U.S. Frankly, I would advise that going forward. There are a number of truly innovative and disruptive companies domiciled in the U.S. that will continue to show explosive global growth. That we have started to really get back on our feet, as vaccinations allow more freedom of economic activity and travel, augurs well for the U.S. So I wouldn’t be surprised if the U.S. continues to be one of the better-performing markets. That wouldn’t preclude us from owning companies in some international markets that are well positioned for growth.
On the international front, you own Tencent Holdings [TCEHY] and Alibaba [BABA]. What do you like there?
We initially got involved with Tencent because it had the dominant gaming platform. Several years ago, Tencent really started to gain traction with messaging app WeChat , one of the most powerful social platforms in the world and certainly the strongest in China. Alibaba is another example. Both are dominant companies, rapidly growing, with little or no debt, and have high return on invested capital in the world’s fastest-growing internet market. Now, both are broadening into payments. Alibaba also happens to be Asia’s leader in cloud processing, analogous to Amazon’s AWS [Amazon Web Services].
Are you worried about China?
We have had some concerns about increased competition in China in the grocery area. Pinduoduo, an online grocer, has created increased competition for Alibaba. Companies have faced increased scrutiny from Chinese regulators who want greater competition. In many ways, it’s ultimately a good thing that the market is competitive in China, because it will mean that the regulatory environment, although more challenging, won’t preclude these companies from experiencing solid growth. And of course, there are geopolitical tensions between China and the U.S., which we monitor.
You began investing in Amazon in 2004. It’s now nearly 11% of your portfolio. That’s a big stake, especially for a $100 billion fund.
We got involved in Amazon early on because we thought they were disruptive in e-commerce. We had no idea that they would grow and develop other businesses. Probably seven or eight years ago, we started to realize that Amazon had three big businesses that were growing much faster than the core retail business: their third-party retail business, which is much more profitable than their first-party sales; AWS; and an ad business.
These have much higher gross margins than the core retail business. That was being obfuscated by the fact that Amazon was spending so much below the gross margin line. But we felt it was inevitable that Amazon’s gross margins would burgeon, and that free cash flow would improve dramatically. We’re probably in the third inning of that happening. We’re also maybe in the middle innings of them really growing their Amazon Prime business. That, combined with the gross margin improvement, made us willing to have an even more material bet on Amazon.
You also have big stakes in other large tech companies.
Alphabet is our second-largest position. Its YouTube unit, in particular, has shown dramatic growth improvement, and the process of monetizing advertising has really started to blossom. Management has gotten much more disciplined on expenses and capital allocation. But the real punchline on Google is that it trades at 22 times the free cash flow that it’ll generate in calendar year 2022. We think it can trade at 30 times cash flow, which would be $3,300.
Why should Alphabet trade at 30 times cash flow?
The consistency and durability of its revenue, earnings, and free cash flow are striking. In the most recent quarter, aggregate revenue was up 34%. You can [dismiss that] as just the most recent quarter, but sales in 2018 were up 53%; in 2019, they were up 18%; and in 2020, 13%. They grew free cash flow by 37% in 2019 and 41% in 2020.
I could make similar arguments for Facebook. It is actually a good bit cheaper than Google. But it’s a little bit more controversial because they’re going to have to deal with some new developments in identifying for advertisers, IDFA, which will make it more difficult for Facebook to target advertisers. [IDFA is a unique random device identifier that Apple generates for advertisers to send targeted ads. Users can opt out through the limited ad-tracking setting on iPhones.] Facebook says it will likely hurt their targeted advertising, and advertising is their most important revenue generator. But they spoke a lot more confidently about IDFA in the most recent quarter. It’ll be a challenge, but they don’t seem to be particularly troubled by the things they’ll need to do to adapt.
Facebook has had fairly significant positive earnings revisions. It’s trading at approximately only 20 times the free cash flow it will generate in calendar 2022. We think the stock can trade at 30 times that free cash flow estimate, or $480.
Free cash flow seems to be at the core of your strategy. Why?
It’s the discretionary cash that a company has available to fund its growth. Return on equity is a book measure. Book earnings and accounting results in general are more subject to manipulation. Free cash flow is much more difficult to manipulate. If you have early-stage or rapidly growing companies that are throwing off a lot of free cash flow, that means they have tremendous flexibility to fund their growth. Many of our companies have free cash flow equal to or greater than their net income.
What non-tech stocks do you like?
Danaher [DHR] just reported incredibly strong earnings. Its diagnostic and testing business, led by Cepheid, grew revenue 31% in the most recent quarter, while its life sciences business, led by bioprocessing powerhouse Cytiva, acquired from GE , grew 42%. Danaher’s core businesses are growing well above expectations, and a substantial portion of the diagnostics and bioprocessing revenue should be sustainable. Danaher can generate over $10 a share in free cash flow in calendar 2022. A price target of $300 is achievable.
OK. One more?
Intuit [INTU] is a name that we’ve had a big overweight on for a number of years. It gives you a good combination of businesses that are somewhat defensive. Intuit is actually a very dominant company in providing tax and financial-planning assistance and accounting and finance packages, like the whole QuickBooks suite of software for small businesses. It’s also a very prodigious generator of free cash flow. We think it can comfortably trade at 35 times free cash flow, or $490.
What will you do in retirement?
A variety of things. Still a lot of active investing, maybe for a few friends and family, but more likely just for myself. I’ve been increasingly involved in some charitable endeavors. The ones that are probably nearest and dearest to my heart are Catholic Charities and Catholic Relief Services. Catholic Relief Services is headquartered in Baltimore; it is really an interesting organization, almost analogous to the Red Cross. The Maryland Food Bank is an outstanding organization, too.
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