On the hunt for small- and mid-caps

With the major stock indexes at or near all-time highs, Fidelity's Will Danoff says he is redoubling his focus on small- and mid-cap stocks with high growth potential.

• Following his longstanding belief that a stock's price follows the actual and expected earnings per share of the underlying company over time, Fidelity Portfolio Manager Will Danoff says he has intensified his efforts to find small- and mid-caps that have high potential for growth.
• "Mid- and small-cap companies can often grow faster and longer than their big-cap brethren simply because their starting point is so much smaller," says Danoff, who's helmed Fidelity^® Contrafund^® since 1990. "In addition, SMID-caps can often innovate faster and capitalize on emerging trends more directly than larger companies."
• The fund is an opportunistic, diversified equity strategy with a large-cap growth bias. Will relies on in-depth bottom-up fundamental analysis to choose companies that can deliver durable multiyear earnings growth that is not accurately reflected in the stocks' current valuation.
• In particular, he emphasizes companies with "best of breed" qualities, including those with a strong competitive position, a high return on capital, solid free-cash-flow generation and a management team that is a disciplined steward of shareholder capital.
• The fund is dominated by well-known large-cap growth names that headline its benchmark, the S&P 500^® index. Will explains that his interest in SMID-caps is based on his goal of generating alpha and to more fully understand industry dynamics that affect companies of all sizes.
• In Will's view, many of the largest-cap companies have appreciated faster than their underlying EPS growth. He cites personal-electronics maker Apple as an example. "The stock gained 34% for the 18 months ending October 31, but EPS increased only 12%. So I am looking for opportunities where valuations are less stretched," he says.
• SMIDs are sometimes less well-known, so their valuation can improve as they grow and are discovered, according to Danoff, noting that the most appealing companies can benefit from faster EPS growth and an expanding earnings multiple.
• Danoff says he is particularly keen on select companies that emerged during the late-2020 initial public offering frenzy. "Some have now grown steadily for three or four years, are battle tested, and often at the same or only slightly higher valuation as when they went public," he points out.
• As examples of what he is looking for, he specifically cites three faster-growing non-index names, all based in the United States. Software maker Samsara provides asset-tracking systems for transportation firms, construction companies and government agencies. It first issued shares in 2021. Duolingo, also a public company since 2021, is a provider of language-teaching apps. Reddit is a social-media business that went public in March 2024.
• All are fund holdings as of October 31, and Danoff is optimistic their impact down the road can be big, along with other SMID-caps. "Working with the Fidelity research department, we are looking throughout the world for fast-growing, well-managed companies that the fund can own for many years and that we think have the potential to become mega-cap companies," he concludes.