Richard Driehaus's stock-picking operation, Driehaus Capital Management Inc., based in an ornate former funeral home in Chicago, shot the lights out last year.
Its international funds, which are the only portfolios available as mutual funds, beat relevant benchmark returns by factors of up to 10 to 1. His two principal domestic portfolios, which are not available as funds, returned 197 percent last year in small-cap stocks and 222 percent in mid-cap stocks.
Annual performance of the two domestic portfolios was up more than 30 percent over the past 10 years, more than double their benchmarks.
Earlier this month, the financial weekly Barron's named Driehaus to a 25-member roster of fund managers called the All-Century Team, along with such luminaries as Peter Lynch, John Templeton, Ned Johnson and Mario Gabelli.
Afterward he talked about how he and his team do it--and dropped some stock picks.
Q: Last year was your best ever, while many small- and mid-cap managers suffered. How did 1999 compare to previous winners?
A: Our previous best year was 1991. About 60 percent of our portfolio was health-care related. We made a lot of money in U.S. Surgical, which was a home run for us.
We don't try to hit singles and doubles, which a lot of consultants prefer that you say because it sounds more consistent. We don't mind hitting a home run, because it's the outlier that can add to your incremental returns.
After 1995, we had a harder time finding a home run. It wasn't until last year that we found other home-run ideas, and they were companies in the area of fiber optics, fiber channel or photonics.
We're leaving the electrical age, which started over 100 years ago. Now we're going from the electronics era to photonics or fiber--light that will both transmit and store data. Our first stock in this area was QLogic.
Q: What is your philosophy as a growth-stock manager?
A: Sometimes occurrence, or the fact that something there is more important than size. Let me give you an example. Say there's a little fungus on a pond. The fact that it's there is more significant than how large it is. Early detection becomes very important in adding to your superior returns.
We embrace change. Warren Buffett is looking at oligopolies and monopolies. We're into change. There's an increasing rate of change. That's giving us market opportunities.
We've made money in three areas--consumer cyclicals--Wal-Mart, Home Depot--health care and technology.
Q: Tell me about how you value stocks.
A: When you were coming out of a Depression, you wanted to have great liquidity and strong balance sheets. This had less impact as technology came along and the new economy started to unfold.
The new methods are not based on price-to-book or dividends. They are based on product development, technology promise, the quality of your product line, intellectual capital.
We have no absolute price-earnings multiple for a stock. On the other hand, we don't want to be gratuitous and just buy anything. In fact, we're being more careful now. Terms in the industry are used, like "hockey-stick growth." They talk about business tornadoes that just dominate an area, like Cisco [Systems]. We're looking for the stocks that may have those characteristics.
In general, we do not look at balance sheets. We look at the income statement and what's driving the sales and the earnings. We look at things that would indicate that what's happened recently--a positive earnings surprise--is going to continue. In manufacturing, we would look at backlogs. In retailing, we look at same-store sales growth.
Q: So, stock valuation is an evolving concept?
A: You have to be open about it. The mind is like a parachute. It's only good when it's open. Part of our portfolios develop almost like a venture capital fund. We can't really measure adequately by our normal tools, so we'll look at the market potential.
Fiber optics, even though it is very embryonic, is showing sales and earnings in the here and now.
With biotech, it's basically technology that has been developed, but they are really not generating any sales and earnings, or it's extremely modest. There, you have to look at the market potential.
Q: Give us your near-term market outlook.
A: We're saying the technology-sector stocks could be peaking and the market could be broadening out. The market may be setting up for a consolidation. We're selling stocks that are very extended--up 10 times in the last 18 months--and buying stocks that are up two times.
We're selling stocks that are trading at infinite multiples [of earnings per share to price] and buying stocks that are selling at [price/earnings ratios of] 30 to 50. We're trying to be more defensive--to keep [P/Es] under 100.