How This T. Rowe Price Stock Picker Tries to Avoid Mistakes

Will growth stocks continue to outperform? That’s the question on some investors’ minds, especially after the outperformance of the so-called “Magnificent Seven” stocks in 2023. Or could it be that unloved value stocks are poised for a mean reversion and will outperform next year?

For some, the choice is not between value or growth, and they invest in both. Peter Bates, a core equity portfolio manager at T. Rowe Price, is one such investor. “My job is to beat the market, and I’m not going to beat the market by taking a directional bet on growth or value. I’m going to maintain balance and let my stock-picking drive my value,” he explains.

Instead of thinking about whether a value rotation could materialize, Bates finds and owns the best company in a segment and then sticks to his discipline of balancing risk and returns. He runs the T. Rowe Price Global Select Equity Fund, a concentrated, style-agnostic core portfolio with 35 stock holdings. (The fund is not available to U.S. investors.) Bates is also a member of T. Rowe’s investment advisory committees for its US Dividend Growth Equity, US Large-Cap Core Equity, and US Value Equity strategies

While on a recent trip to Hong Kong, Bates told Morningstar: “If you’re a growth manager and value is winning in 2022, you’re like, ‘Oh, it’s just a terrible market for growth. I can’t do anything about it.’ To me, that’s an excuse.”

Two Mistakes for Stock Pickers to Avoid

Outside of style, Bates has seen two mistakes in his 20-year career that “aren’t something I want to be guilty of.”

His first lesson is to not ignore cyclical risk. “When you have a bad cyclical event, you cannot throw your hands in the air saying, ‘Who could have predicted that would happen?’ I saw that all around me during the global financial crisis. I think, as investors, we have a responsibility to think about risk/return and not just always think positively.”

His job is no different from that of other stock pickers: to identify the future in a repeatable process. That’s why, in the meantime, he thinks managing risk plays a big role in his fund.

“I think to be overly concentrated is reckless,” he says. “I know some of the concentrated strategies out there that I’m competing against. Frankly, I think they’re reckless because they’ll have two or three positions that might be 30% of the fund. If they’re wrong on one of those positions, it’s going to overwhelm everything happening with the rest.”

He instead expresses preferences by ranging each stock’s weight between 2% and 4%. According to Morningstar, his portfolio had an active share score of 90 at the end of October 2023.

‘No Excuses Doesn’t Mean No Mistakes’

Bates candidly admits to some recent lessons he’s had to learn. “I still make mistakes. I’m still trying to learn. I’m certain to make stock mistakes, and I’m certain to have periods when I underperform. But it will be because of stock mistakes, not because I’m making reckless macro bets.”

He elaborates: “With 35 stocks, I need to be right 20-25 times. But I also need to make sure if I am following my process, that when I’m wrong, it’s not going to cost me a bunch of money. That’s part of risk/return, and I very much think about risk/return. And I want to buy stocks when I’m paid to take the risk for owning them. If you’re not paid to take the risk, don’t own the stock.”

Bates says that for each of the 35 stocks he owns, “I am almost comparing it to five or more similar type companies to decide which one offers the best risk/return, and then that’s the one I’m trying to own.”

Manager’s Bet Against Nvidia Did Not Work Out

Bates highlights the struggle between quality and valuation as it played out with investor darling Nvidia NVDA. In January, Bates was deciding his bets for a semiconductor cycle. “There have been a lot of headwinds, and to me, it felt like a good place to take cyclical risk,” he recalls. “At the time, I owned Advanced Micro Devices AMD, the B asset, while Nvidia was the A asset. Nvidia was more expensive than AMD in our estimates. I felt like I had better downside support in AMD and ultimately better risk/return. As the year progressed, we massively underestimated the upside in Nvidia.”

Going into the summer, Bates realized that AMD was further behind on GPUs than he thought, and that its knowledge gap with Nvidia was wider than initially anticipated. “Part of the AMD thesis was that the company was really good in CPUs and taking share and working hard to develop a GPU. Obviously, Nvidia dominates GPUs. The market wants more than one player. We felt that the second player would be AMD. Even if it’s 10% or 15% of the market, it’s material for AMD.” But he says the investment thesis “kind of failed.”

Even though Nvidia’s year-to-date return is greater than AMD’s, Bates felt it was right to make the switch because there’s less opportunity and more risk in AMD. “I am concentrated and often want to own the best company, even if it’s a little more expensive. I made a mistake that cost me 150 basis points because I didn’t do that this year,” he says. In September, Bates decided to liquidate the fund’s positions in AMD and ASML Holding AMSL, then use those weightings to buy Nvidia shares.

Another Liquidated Position: Yum China

While semiconductor stocks are one example of holdings Bates has because of a structural trend, he’s made some trades based on shorter-term trends as well. China lifting its COVID-19 restrictions is one example; he played with Yum China YUMC, which operates KFC and Pizza Hut stores on the mainland.

Bates explains: “Yum China was definitely a China reopening story. The company really pivoted to make its stores more cost-efficient with things like online or digital kiosk ordering to reduce labor.” As China was reopening, the investment thesis was that sales per store at Yum China would recover to previous levels, and the margins would be higher because of the reduced cost.

“The thesis played out, and as soon as there was evidence that sales had recovered [as much as they were going to], I didn’t want to own it for the next leg of the thesis, which was just opening more and more stores,” he says.

The fund owned 1.5% of Yum China before liquidating its position. “We only made like 10%. It wasn’t a bad investment, it wasn’t a great investment, but it was time to move on.”