An Eye for Innovation

David E. Saunders II is the very definition of a growth investor. As a senior research analyst for Credo Capital Management in Baltimore, he’s responsible for investment research and assisting in portfolio management. True to the growth philosophy, Saunders seeks high returns by owning a piece of companies that are expected to post revenue and earnings growth in the coming years. The trick, of course, is finding those companies before hoards of investors drive up their share prices. To do that, Saunders pays special attention to growth companies that are priced low but that have unique, innovative technologies that give them an advantage in the marketplace. Saunders recently talked to Black Enterprise about three such companies that he believes are destined for outsized growth–even in a long, slow economic recovery.

Let’s talk about the big picture a bit. What’s your take on how the markets performed in 2009, and what’s ahead?

We always see the market react in the extreme. Last winter, pessimism was overdone–in the spring and summer, there was overconfidence. As the economic numbers continue to come out, there may be more skepticism on the part of investors. We don’t think it’s going to be a straight-shot recovery. The market will likely pull back over the next few months. We don’t think we’re out of the woods yet, but we’re heading in the right direction. We’ve all overreacted in our optimism for the economy recovering quickly. You have a lot of uncertainties, like healthcare reform. There are a lot of question marks out there. And I don’t think we’ve seen enough growth to sustain this rally. For the “P” [share prices] to keep going up, you have to see the “E” [earnings] go up.

How do you see the economic recovery playing out?

Well, we’re not economists, and we don’t pretend to be. If you ask me, the second half of this year should be easier on companies. We look for the rate of unemployment growth to slow. I think that’s going to be positive from a psychological standpoint.

Is it difficult to sniff out growth prospects in this environment? Many companies posted better-than-expected earnings over the summer by cutting costs. But that’s not the kind of growth you’re looking for.

Right. Cost cutting is not going to be sustainable–it’s not been a great market for growth. We’re growth investors, so we pay attention to revenue and earnings growth. We’re asking companies what they’re doing to produce top-line growth. We look for potential changes in key areas of the business: market expansion, acquisitions, supply expansion, the number of stores, product development, channel productivity, revenue per salesperson, and how well the company uses its assets.

So where do you begin to look for real growers?

Companies that have unique products. Take Coinstar (CSTR), in which we first purchased shares in December 2008. They own Redbox, which operates about 18,000 automated kiosks around the country. Consumers can use these self-service kiosks to rent or purchase DVDs. Each machine has about 500 titles, 200 of which are new releases that can be rented for $1 a day. You can find them in quick-service restaurants, grocery stores, convenience stores, and other retailers. You can rent four DVDs for less than it would cost to rent one at most Blockbusters. Redbox is a threat to Blockbuster and mom-and-pop video shops. The risk is that the entertainment studios are pushing back on having their movies released early, but they’re negotiating with Redbox. This is a game-changing business model.