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Consumer Stocks Thriving Despite Sour Mood

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Anxiety persists three years after the recession officially ended. Consumer confidence remains well below the level that would suggest a healthy economy. The job market is weak, the housing recovery slow and uneven.

Yet investors have recently had plenty of opportunity to earn strong stock returns from companies that depend on consumers to spend and borrow.

Shares of payment processor Visa have surged more than 60 percent the past 12 months, more than double the gain for the Standard & Poor's 500 index. Rival MasterCard is up more than 40 percent. Many retailers have been doing even better, with gains of more than 70 percent at Ross Stores, Dollar Tree and TJX.

Those stocks have one thing in common, besides their consumer orientation. Each is in the portfolio of Akre Focus, a mutual fund that's been one of the strongest recent performers in the mid-cap growth category. Just two of the hundreds of funds in its peer group have topped its 34 percent return over the past 12 months.

More than three-quarters of the portfolio was recently invested in stocks of financial services or consumer-oriented companies. Most of those holdings have outperformed the broader market as consumer behavior shifts. Shoppers have become more cost-conscious, helping to fuel profit growth at many discount retailers. Card networks such as Visa and MasterCard have expanded as electronic transactions chip away at the global dominance of cash payments.

Any stock that has recently generated market-beating returns deserves special scrutiny from investors. The market may already have priced in the strong expectations for those companies, so any new investment could come at a steep price if momentum can't be maintained.

But Akre Fund manager Chuck Akre continues to see strong potential in MasterCard, his top holding in the concentrated portfolio of 28 stocks, and in Visa. He's also sticking with other holdings including Ross, owner of Ross Dress for Less stores; Dollar Tree, a purveyor of items costing a dollar or less; and TJX, which runs the T.J. Maxx and Marshalls chains.

Akre averaged market-beating annual returns of nearly 13 percent running the FBR Focus Fund . He left and started his own fund nearly three years ago. Akre Focus currently has a bronze-medal rating from Morningstar based on its analysts' assessment of the fund's prospects.

Here are excerpts from a recent interview:

Q: Shares of Visa and MasterCard have risen sharply. Why do you continue to like these stocks for the long-term?

A: These are extraordinary businesses. They have 'toll booth' models and operate in much the same way that Microsoft did when it became the dominant operating system for personal computers. As the PC market grew, Microsoft owned the operating system, and you were going to pay for it. Visa and MasterCard are the dominant players in what we might call the 'rails' over which electronic transactions take place worldwide, among the millions of merchants where their cards are accepted.

Their customers on both ends are banks — those that issue cards to customers and banks for the merchants on the other end. It doesn't make any difference whether it's a card swipe or a payment made using a mobile device. Many of those transactions are going over the rails of MasterCard and Visa. There's a lot of growth potential, because 85 percent of the world's transactions involving an exchange of value are still done by cash or check. The 15 percent done electronically can only go up. It's a phenomenon that will continue to grow worldwide.

Q: Even with such potential, a company must execute well to generate strong profits. What do you think about MasterCard and Visa?

A: It's not unusual for them to post after-tax profit margins of greater than 30 percent for a given year. Compare that with the single-digit margins that are typical for American businesses. They are doing something unique that causes them to have such high returns on their capital.

Q: Visa and MasterCard last month reached a transaction fee settlement that requires them along with some major banks to pay at least $6 billion to retailers. Some major retailers will be allowed to charge customers more if they pay using a credit card. Is that a risk for Visa and MasterCard? They could make less from transaction fees if some customers switch back to paying with cash or checks.

A: If it works out the way the settlement has been agreed upon, MasterCard and Visa are both fully reserved for it, and it's been accounted for in their earnings. (Note: For example, Visa increased its litigation provision by $4.1 billion for its recently ended fiscal third quarter, which led the company to post a loss of $1.8 billion.) But that won't alter their broad outlooks.

Q: Your fund doesn't own any shares of American Express and Discover Financial Services. Why?

A: Not as many merchants accept American Express, and I like the ubiquity of the Visa and MasterCard acceptance worldwide. As for Discover, it's an also-ran. That doesn't mean it always will be, but that's where it stands now. Also, American Express and Discover are both lenders, in that they issue cards. Visa and MasterCard are more of a pure play in payment processing. They are the rails.

Q: Why hold onto Ross, Dollar Tree and TJX after the recent surge in the prices of those stocks?

A: These are superbly run businesses, and they've really hit the ball out of the park, no matter what the economy has been doing over the past decade.

They'll continue to do well because we're in an environment in which the consumer is constrained. That will continue, certainly far out into the horizon. Any business whose model is designed to allow the consumer to stretch the dollar and get more for their money will be well-positioned. These stocks are more expensive now, so we haven't added money to them recently. But we will get our chances.

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