The Hennessy Cornerstone Growth Fund has a formula that has allowed it to consistently outperform the S&P 500. According to portfolio managers Neil Hennessy, Ryan Kelly and Joshua Wayne, the fund employs a formula-based investment strategy. “This allows us to be consistent over time,” Kelly and Wayne said in an interview with CNBC Pro earlier this month. And this outperformance has proven sustainable, even though it hasn't bought the large-cap stocks that have repeatedly led the S&P 500 to record highs. The fund gained 66.23% over the past year through May 31, beating the S&P 500's 28.19% over the same period. And looking over the past five years, the fund has still outperformed the S&P 500, posting an average annual total return of 20.82%, beating the index's 15.8% over that period. And since the fund began in 1996, it has posted an average annual total return of 10.13%, outperforming the S&P 500's 9.58%. Kelly will walk you through the step-by-step strategy he has used since the fund's inception, which he likens to a “giant funnel.” About 5,000 stocks are narrowed down to 50 from all companies listed in the U.S., including foreign stocks listed as American Depositary Receipts. Each stock will have a 2% shareholding. Stocks must meet the following criteria: Market capitalization must be at least $175 million; They must have a price-to-earnings ratio of less than 1.5, have earnings growth year-over-year, and have positive three- and six-month stock price returns. This leaves about 100 to 150 stocks to choose from. They rank them based on their stock price performance over the course of a year to select the final 50 stocks. “We try to combine value with momentum and some growth,” Kelly said. Those two elements have “worked extremely well” for the fund, he added. “We end up finding companies to put in the portfolio, high-quality companies — companies that are trading at low valuations but have some earnings growth that are already starting to turn around, and we see that as the stock price rises in a positive way over three and six months, we see the stock price of those companies rise.” [got] “There's something good going on,” he added. No matter how well any stock in the portfolio performs this year, the fund manager uses this method to rebalance the fund every winter. “You don't hold at the bottom or on the way up, and there might still be good runway after that. And… you hold to very strict valuation criteria, but you also combine that with momentum. I think that's what differentiates this fund, and that's what's made it successful.” [it] “It's been doing well for a number of years,” Kelly said. One popular stock that was dropped from the most recent selection last winter was Supermicro Computer. The stock, which makes artificial intelligence systems and graphics processing unit servers, has soared since last year amid the AI boom, at one point rivaling Nvidia's gains. It's an example of “taking the emotion out of” investing, Wayne said, noting that Supermicro rose more than 900% between the time he bought the stock and the time he sold it. But in the past three months, the stock has fallen nearly 15%. “After it went up 100% or 200%, [return] I would say 90% of people sold it. And maybe 500% [return] “Maybe one in a million people would have held on,” Wayne said. “Regardless of how they do it, if they don't meet their criteria they sell, but they're likely to miss the upside, but I think they usually catch the upside. I think that says a lot.” What stocks the fund holds Most of the fund's stocks that are doing well aren't actually tech stocks, but rather stocks in the industrial, consumer, financial and healthcare sectors. This is because of the formula the fund uses. The required price-to-sales multiple is less than 1.5 times, Wayne said, automatically disqualifying many of the more profitable companies in tech and pharmaceutical. Kelly said that because of these criteria, mega-cap tech stocks “don't make it into the portfolio.” The fund also promises “growth at a fair price,” and the “fair price metric” they use is price-to-sales, Kelly added. “Only about a third” of the overall market holds tech stocks. [that] The stock trades at less than 1.5 times sales. “That's a very restrictive number,” he said. “So we're making sure we're buying at the right price.” These are the stocks that contributed most to the fund's outperformance over three periods: the past year through June, year-to-date, and from the most recent rebalancing in mid-April through June 20. They discussed three “representative” U.S. stocks in terms of growth and the definition of “good valuation.” One is Emcor, an industrial company that provides building and construction services. It is the only stock that survived the recent rebalancing to 50 stocks, according to Wayne. “They've benefited to some extent, at least in the U.S., from increased infrastructure investments in data centers, pharmaceutical manufacturing, semiconductor manufacturing,” he said. “All these facilities need to be built and ventilated.” Another is Urban Outfitters, which was a “big name” decades ago but “has kind of been forgotten,” Wayne said. He added that while its core brand has “lost steam,” other brands it controls, such as Free People, “are growing well.” The firm's third favorite is Bluebird, a bus maker known for building school buses that has expanded into electric buses. Wayne noted that it's the best-performing electric-vehicle stock so far this year. “I don't think growth investors are going to look at an established school bus maker,” Wayne said. “So an investment doesn't have to be that exciting to get good returns. You just have to look where other people aren't looking. And I think this framework forces us to look at areas we would never look at.”
