This five-star fund manager keeps beating index funds by picking 'hidden compounders' and holding them for years. Here's why he held Super Micro.

By Philip van Doorn

John Barr takes a long-term approach while waiting for selected companies to bloom

The Needham Aggressive Growth Fund has a coveted five-star rating (the highest) within Morningstar's "Small Growth" fund category. The success of the fund's strategy is also remarkable when compared with broad stock indexes.

John Barr, the fund's portfolio manager, explained how selects companies for investment during an interview with MarketWatch.

Needham Investment Management is based in New York and has $990 million in assets under management. Barr joined the firm in 2009 and has run the Needham Aggressive Growth Fund since 2010. (See below for a detailed look at how well the fund has performed.)

The Needham Aggressive Growth Fund has about $600 million in assets. It has more than doubled in size over the past year, reflecting its 43% return during that period and an inflow of new money. The fund held 77 stocks as of Dec. 31, with a 30% concentration in its largest 10 holdings. The concentration has been reduced as more money has flowed in, Barr said.

He is a long-term buy-and-hold investor, who initially selects small-cap or microcap companies he believes are "hidden quality compounders." A typical company he selects has "a legacy business or product line that is profitable or generating cash, and is investing in something new - a product or service," he said.

Barr's strategy is to begin by taking small positions - up to 2% of the portfolio - in the companies he identifies and see how they work out over time. Initially, their overall financial condition might appear to be unremarkable, he said, but they meet the following criteria:

They are investing to develop new products or services.They can become five to 10 times larger.They have "great management," which might might include a company's founder, the founder's company, or long-tenured executives.The share price is attractive.

Over time, as a selected company's operating performance begins to improve, Barr will add to that stock position. He hopes to see the companies move from being hidden compounders to those making a "transition," eventually to become "quality compounders."

When the thesis is on-track, we hold on.John Barr, portfolio manager of the Needham Aggressive Growth Fund.

"Fewer work than don't work," Barr said of his stock-selection process and how he manages the portfolio. He emphasized the need for long-term investors not only to be patient but to take action and move on from bad positions.

"There are hidden compounders that never make it. But the reason we have the results we do is that enough have worked in such scale that they have produced good results," he said.

If everything works out for a company and the share price shoots up, Barr will begin selling shares if that position has grown to be about 10% of the portfolio. Because of the fund's small-cap focus, he will generally avoid adding to a position if a company has grown to a market capitalization of more than $10 billion.

Barr talked about several of the fund's individual holdings. First, here's a list of the fund's top 10 positions as of Dec. 31:

   Company                                                                   Ticker   % of the Needham Aggressive Growth Fund  12-month return  Year shares were first purchased  Barr's current stage category 
   Super Micro Computer Inc.                                                  SMCI                                       5.1%           1,015%                              2009                        Quality 
   Aspen Aerogels Inc.                                                        ASPN                                       3.4%              57%                              2012                     Transition 
   PDF Solutions Inc.                                                         PDFS                                       2.2%             -14%                              2010                     Transition 
   Vertiv Holdings Co. Class A                                                VRT                                        2.5%             328%                              2021                        Quality 
   Unisys Corp.                                                               UIS                                        1.8%               6%                              2021                         Hidden 
   Vishay Precision Group Inc.                                                VPG                                        1.9%             -24%                              2016                         Hidden 
   Vicor Corp.                                                                VICR                                       1.6%             -19%                              2014                         Hidden 
   Oil-Dri Corp. of America                                                   ODC                                        1.9%              92%                              2012                        Quality 
   Nova Ltd.                                                                  NVMI                                       2.1%              98%                              2009                        Quality 
   Entegris Inc.                                                              ENTG                                       1.6%              56%                              2010                        Quality 
                                                                                                                                        Sources: Needham Investment Management and FactSet (for stock returns) 

Click the tickers for more about each stock, including corporate profiles and financials.

Read: Tomi Kilgore's detailed guide to the wealth of information available for free on the MarketWatch quote page.

Super Micro

Barr first purchased shares of Super Micro Computer Inc. (SMCI) for the fund in 2009. This is an example of how patience can be rewarded. From the end of 2009 through 2012, the stock was down 8%. But it has soared over the past few years.

Super Micro is an example of a company that has gone through the three phases Barr wants to see, he said, moving from hidden, to transition to becoming a quality compounder. The company went from making PC motherboards used by enthusiasts, to "going upmarket" by making servers, after which it added storage equipment, network-management software - and then "went to whole server racks," he said.

"Every one of those additions took several years to play out, but there was always something ahead," he added.

The amazing performance of the stock over the past year reflects the growth (or expected growth) of Super Micro's business supplying server racks to AI data centers.

This is a stock Barr may have started to trim since the fund disclosed its Dec. 31 portfolio. Its market cap is now $63.5 billion, which is way above his target range for a small-cap fund. But he would stick with the position if it weren't close to his 10% portfolio position cap.

"We hold for a really long time. When the thesis is on-track, we hold on," he said.

Vicor

On the table you can see each company's current stage, according to Barr's analysis. He said that Vicor Corp. (VICR), which he first purchased for the fund in 2014, was an example of a company that had "gone from hidden, to transition, to quality and now back to transition."

Vicor makes equipment used to convert higher-voltage electricity sources to the lower voltages needed to operate servers and other computer equipment. Barr said Vicor had missed an industry product cycle as it worked to build a "fifth-generation product, later than expected."

He expects the company's new plant in Andover, Mass., to come online soon, enabling Vicor to provide power converters "necessary for future processors and datacenters, particularly AI datacenters."

Unisys

Unisys Corp. (UIS) is a name that might be familiar to you - the company's roots go back to the 1870s, although it was named Unisys in 1986 when it was formed through the merger of Sperry and Burroughs.

The company's legacy business has been making mainframe computers and the software that runs on them. More recently it has evolved its ClearPath Foward transaction-processing system so that it can run on cloud networks, in addition to mainframes.

"It has all the modern capabilities," Barr said.

Unisys has a market cap of $352 million. The stock is volatile because of legacy pension liabilities that Barr said total about $1 billion. He said he believes the company should be valued on a sum-of-the-parts basis as high as $20 a share, and "certainly" $10 a share. The stock closed Monday at $5.12, and might be a takeover target, Barr said.

Oil-Dri

Oil-Dri Corp. of America (ODC) hit its stride to become a quality compounder in 2022, when its sales began it increase rapidly, Barr said. The company's legacy business is absorbent clay products used for industrial purposes. It was founded in 1941 by Nick Jaffee, whose family still controls Oil-Dri; Daniel Jaffee now serves as chief executive.

Years of investment in two newer businesses are now bearing fruit, Barr said. These include premium light-weight cat litter sold under the Cat's Pride and Jonny Cat brands, as well as private labels. Another long-term initiative bearing fruit is clay-based food supplements for livestock, meant to lower reliance on antibiotics.

Even though Barr considers Oil-Dri to be a company that has hit its stride, the stock flies under the radar with no coverage among analysts working for brokerage firms, according to FactSet.

Barr said that he is impressed with Oil-Dri's management, which conducts a quarterly conference call but doesn't present at industry conferences. "They focus on running the business," he said.

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