June 13, 2024

The Art of Investment

Mastering the Stock Market Strategies

5 Growth Stocks to Buy From the Best Money Managers

12 min read

Even after the recent stock market pullback, attractive large-cap growth stocks are tough to find. But those investors willing to step down a few rungs on the market-capitalization ladder have more undervalued growth stock picks to choose from.

“While growth stocks, as a group, trade near our fair value estimate, we continue to see significant value among smaller-cap growth stocks,” says Morningstar chief US market strategist Dave Sekera.

To find small- and mid-cap growth stocks to buy that are not just undervalued but that also hold promise, we peeked into the portfolios of some of the best active managers running concentrated US mid- and small-cap growth funds. The managers of these funds (just eight in total) have confidence in their stock picks―and Morningstar has confidence in their stock-picking skills.

5 Growth Stock Picks to Buy From the Best Money Managers

These stock picks are popular among the best concentrated money managers in Morningstar’s mid- and small-cap growth fund categories; these stocks also earn Morningstar Ratings of 4 or 5 stars, suggesting that they’re undervalued. Data is as of April 19, 2024.

  1. Veeva Systems VEEV
  2. Smartsheet SMAR
  3. Tyler Technologies TYL
  4. Paycom Software PAYC
  5. Zscaler ZS

Here’s a little bit about each growth stock to buy, along with some commentary from the analyst who follows the company. All data is as of April 19, 2024.

Veeva Systems

  • Number of best managers who own the stock: 3
  • Morningstar Rating for Stocks: 4 stars
  • Morningstar Economic Moat Rating: Wide
  • Morningstar Style Box: Mid Growth
  • Sector: Healthcare

Veeva Systems tops our list of top growth stocks to buy from the best money managers. The global leading supplier of cloud-based software solutions for the life sciences industry, Veeva earns a wide economic moat rating thanks to its high switching costs. The company maintains a sticky revenue stream that’s noncyclical, explains Morningstar analyst Keonhee Kim. Although macroeconomic forces pose headwinds to its services segment in the near term, we expect Veeva’s customer penetration to deepen as customers subscribe to an increasing number of add-on modules, he argues. This undervalued growth stock pick trades 27% below our $270 fair value estimate.

Veeva is the leading provider of cloud-based software solutions tailored to the life sciences industry. It provides an ecosystem of products to address the operating challenges and regulatory requirements that companies in the space face. Instead of focusing on a general, one-size-fits-all system, Veeva has created platforms that are purely designed to serve one industry. And this vertical focus has allowed the company to shape its products for its specific customers to fit their specific needs. Veeva is deeply penetrated in its addressable market, and its continued expanding portfolio of applications presents itself as one of the most attractive offerings in the space.

The company operates in two categories: commercial solutions and R&D solutions. Commercial solutions entails vertically integrated customer relationship management, or CRM, services and end-market data and analytics solutions mainly through its CRM and add-ons. Veeva CRM is Veeva’s cloud-based customer relationship management platform that markets to pharmaceutical and biotech companies with commercial needs. CRM was originally built on the Salesforce 1 platform, but Veeva announced in late 2022 that it will migrate the product to its own Vault platform. Customer migration will begin in 2024 and existing users can use CRM on Salesforce’s platform until 2030. We believe Veeva’s Vault platform is well developed to easily handle both CRM and R&D applications, and this move away from Salesforce gives the firm the independence to run all its offerings.

R&D solutions horizontally integrates data and content through Veeva Vault. Veeva Vault is Veeva’s content management system that is built on the company’s own platform, and it is the industry’s first tool that offers all applications in a unified and integrated server. It is a suite of applications that aims to help across five specific functions (commercial, clinical, regulatory, quality and manufacturing, and safety) within any company that is developing drugs or suppliers to those who are developing drugs.

Keonhee Kim, Morningstar analyst

Smartsheet

  • Number of best managers who own the stock: 3
  • Morningstar Rating for Stocks: 4 stars
  • Morningstar Economic Moat Rating: Narrow
  • Morningstar Style Box: Small Growth
  • Sector: Technology

The first technology name on our list of top growth stock picks, Smartsheet trades 34% below our fair value estimate. A provider of collaborative work management software, Smartsheet boasts strong retention metrics, which underpin our narrow economic moat rating, explains Morningstar analyst Emma Williams. We expect revenue to grow at a compound annual growth rate of 18% over the next five years. We think the stock is worth $56 per share.

Smartsheet is a leading provider of collaborative work management, or CWM, SaaS solutions. The emerging SaaS niche aims to improve the efficiency and productivity of project and process management by displacing widely deployed but suboptimal incumbent tools of email and spreadsheets. Smartsheet’s platform allows nontechnical users to configure, automate, and visualize custom workflows and notifications, dynamically assign tasks and permission data access, and build centralized dashboards for real-time visibility, accountability, and consistency across projects. The platform leverages integrations to adjacent business applications and productivity tools to centralize data, reduce error-prone manual data entry, and improve process efficiency.

Smartsheet has leveraged a freemium go-to-market motion and heavy investment in product innovation and platform infrastructure to secure a solid footing in the sticky enterprise market. While multiple CWM vendors will likely capture share of the expansive addressable market for purpose-built project management tools, we believe Smartsheet is well placed to rapidly expand within existing clients and become the enterprise, IT-certified vendor of choice. At present, sprawling enterprises likely engage multiple CWM solutions concurrently for siloed projects; however, we expect efforts to standardize internal processes and optimize project management will lead to provider consolidation over the long term. This dynamic will benefit providers like Smartsheet with the security, scalability, and compliance features enterprise clients demand.

We expect Smartsheet to win new clients and take greater share through free user conversion and module adoption, while embedding the platform further into mission-critical operations. We anticipate Smartsheet will continue with a successful playbook of growing seat expansion through the organic or assisted identification of new cases, and uptake of higher-margin capabilities. While over 30% of 2024 revenue was derived from add-on capabilities, less than 10% of the customer base had adopted these solutions, providing ample scope for further penetration.

Emma Williams, Morningstar analyst

Tyler Technologies

  • Number of best managers who own the stock: 3
  • Morningstar Rating for Stocks: 4 stars
  • Morningstar Economic Moat Rating: Wide
  • Morningstar Style Box: Mid Growth
  • Sector: Technology

Tyler Technologies is the second wide-moat company on our lineup of growth stock picks to buy. Its wide moat stems from its leadership position in vertical software for governmental bodies, notes Morningstar senior analyst Dan Romanoff. We model a five-year revenue compound annual growth rate of 9%; revenue growth will be driven by new customers and increasing deal sizes, adds Romanoff. Tyler Technologies stock is 17% undervalued relative to our $485 fair value estimate.

We view Tyler Technologies as the clear leader in a sleepy and underserved public service software niche market. We believe there is a decadelong runway for normalized top-line growth near 10% at Tyler, especially as demand for SaaS accelerates and the need to modernize local governments’ legacy enterprise resource planning systems intensifies.

The firm’s three core products are Munis, which is the core ERP system, Odyssey, which is the court management system, and a web-enabled transactional platform. These systems enable normal operations of governmental units, including financial management, human resources, revenue management, tax billing, and asset management. Tyler addresses the needs of cities, counties, schools, courts, and other local government entities. We believe existing core systems at customer sites are at least 20 years old and running on ancient software code where there is no next wave of incoming, fluent programmers to keep these systems running. We think extending the life of these legacy systems is no longer tenable.

Tyler has also moved more meaningfully toward more transactional recurring revenue through several avenues. E-Filing for court documents and local village hall web portals for basic services like paying a water bill online have been the primary sources for these revenues over the last five years. Further, the April 2021 acquisition of NIC Inc., a leader in government solutions and payments, punctuated this move to more transactionally recurring revenue in our view.

Lastly, we see Tyler’s expanding portfolio as driving larger deals that encompass more solutions. While the company used to fight for every $100,000 deal, it now has established enough of a reputation in the governmental market that it is called upon in most relevant government system searches. The potential clients have certainly grown larger, as evidenced by a variety of statewide e-filing, transactional, and court system deals that are worth tens of millions of dollars annually. Further, Tyler benefits from a fragmented market that includes no companies at anywhere near its size or scale that are focused on the local public institution market.

Dan Romanoff, Morningstar senior analyst

Paycom Software

  • Number of best managers who own the stock: 2
  • Morningstar Rating for Stocks: 4 stars
  • Morningstar Economic Moat Rating: Narrow
  • Morningstar Style Box: Mid Growth
  • Sector: Technology

Payroll and human capital management software provider Paycom Software has carved out a narrow economic moat, thanks to high customer switching costs. The company is undergoing a product strategy shift and a leadership change, which raises some uncertainty around the stock, admits Morningstar’s Williams. But we nevertheless expect the company’s high customer switching costs to persist and think shares look attractive. This growth stock pick is 30% undervalued relative to our $260 fair value estimate.

Paycom’s unified platform appeals to midsize and enterprise clients that prefer an all-in-one payroll and human capital management, or HCM, solution. The company’s platform is supported by a single database, which provides a single source of truth and allows efficient software development and maintenance. Unlike competitors, Paycom discourages data integrations to third-party providers but instead incentivizes clients to contain their HCM solutions within its unified platform by offering add-on modules, including time and attendance and benefits administration. In practice, new clients may consolidate their payroll and HCM solutions from multiple providers to an all-in-one solution by Paycom. The company is squarely focused on driving greater automation and employee self-service, supported by complementary analytics tools for clients and the rollout of its self-service payroll module Better Employee Transaction Interface, or Beti.

We expect Paycom will continue to take market share of the growing payroll and HCM industry through industry consolidation and capitalizing on the shortfalls of competitors. The company has reported impressive growth to date, reflecting an ability to win clients and demonstrating how the cost and efficiency benefits of streamlining payroll and HCM solutions to a single platform can overcome inherent client switching costs.

We anticipate Paycom’s average revenue per client, or ARPC, will increase at an average rate of 7% to 2028 due to a gradual shift upmarket and from taking greater share of wallet through upselling existing and new modules. Paycom’s target market has shifted upward over several years, with the company formally lifting the upper bound to over 10,000 employees in fiscal 2023, from 2,000 in fiscal 2013. While we expect Paycom’s average client size to increase, we expect its offering to be less appealing to mega enterprises that typically prefer to integrate best-of-breed solutions, in our view limiting the upmarket upside for Paycom.

Emma Williams, Morningstar analyst

Zscaler

  • Number of best managers who own the stock: 2
  • Morningstar Rating for Stocks: 4 stars
  • Morningstar Economic Moat Rating: Narrow
  • Morningstar Style Box: Mid Growth
  • Sector: Technology

Trading 21% below our fair value estimate, Zscaler rounds out our list of undervalued growth stock picks from top managers. This pioneer in cybersecurity has carved out a narrow economic moat, and we expect its solutions to enjoy robust enterprise adoption, suggests Morningstar analyst Malik Ahmed Khan. We forecast Zscaler’s revenue to growth at a 28% compound annual growth rate over the next five years, and we think the stock is worth $213.

We see Zscaler as a pioneer and leader in zero-trust security solutions, an area of cybersecurity primed for growth due to secular trends such as increased digitization of an enterprise and a convergence of networking and security. We have a positive outlook on Zscaler’s solutions as the firm stands to materially benefit from these trends. The firm has built out a narrow economic moat by developing a sticky product portfolio, as evidenced by its strong net and gross retention metrics.

Zscaler’s bet was that, over time, enterprises would shift their network-traffic routing from a centralized node (typically the headquarters) to a decentralized direct-to-cloud route. Zscaler’s two key solutions, Zscaler Internet Access and Zscaler Private Access, allow firms to directly connect to external and internal resources, respectively, without needing to route traffic through a centralized node. This shift in how network activity is routed comes at a time when an increasingly large share of enterprise workflows are cloud-based, as digital transformations and cloud migrations alter the IT makeup of enterprises.

However, this change in traffic flow has also created a myriad of problems for enterprises. First, as the reliance on cloud-based resources has grown, the amount of network activity generated by these workflows has rapidly increased. Second, by decentralizing network traffic, there is a need for new security apparatuses and methods to secure the traffic. Last, this shift in network traffic is premised on a zero-trust security infrastructure that removes the risk of lateral mobility, a process in which a malicious actor gains access to one application and then uses its credentials to advance onto other applications.

In this shifting landscape, we believe Zscaler’s solutions stand to be long-term winners. The company’s products have found great enterprise demand, with Zscaler able to attract new customers and expand its customer base. While ZIA and ZPA are two key solutions, both of them consist of many individual modules that allow Zscaler to expand revenue from an existing client by either selling it more seats or increasing the usage of its solutions.

Malik Ahmed Khan, Morningstar analyst

Who Are the Best Money Managers?

To isolate the best active concentrated growth fund managers for this article, we screened on the following:

  • Actively managed funds that land in the US midcap-growth and US small-growth Morningstar Categories.
  • Funds with at least one share class earning a Morningstar Medalist Rating of Gold with 100% analyst coverage.
  • Funds that hold 100 stocks or fewer as of their most recently reported portfolios.

Eight funds passed our screen.

  • Brown Capital Management Small Company BCSIX
  • Champlain MidCap CIPMX
  • Champlain Small Company CIPSX
  • Morgan Stanley Institutional Discovery MPEGX
  • Nationwide Small Company Growth NWSAX
  • Principal MidCap PMBPX
  • Wasatch Core Growth WGROX
  • Wasatch Small Cap Growth WAAEX

We then ran a Stock Intersection report in Morningstar Direct to find undervalued stocks that were popular (as determined by portfolio concentration and number of funds that own the stock) across the funds.

What Are the Morningstar Rating for Stocks and the Morningstar Economic Moat Rating?

The Morningstar Rating for stocks depicts the relationship between a stock’s current price and Morningstar’s fair value estimate of the stock, adjusted for uncertainty. Stocks with 5- and 4-star ratings are undervalued; those with 3-star ratings are fairly valued; and stocks with 2- and 3-star ratings are overvalued.

Morningstar thinks that companies with economic moats possess significant advantages that allow them to successfully fend off competitors for a decade or more. Companies can carve out their economic moats in a variety of different ways—by having high switching costs, through strong brand identities, or by possessing economies of scale, to name just a few. Companies that we think can maintain their competitive advantages for at least 10 years earn narrow economic moat ratings; those we think can successfully compete for 20 years or longer earn wide economic moat ratings.

How to Find More Growth Stocks to Buy

Those looking for additional growth stock picks to investigate further can tap into the following resources.

  • Investors can review Morningstar’s lists of large-cap growth stocks, mid-cap growth stocks, and small-cap growth stocks. The lists aren’t restricted by quality or valuation; rather, they’re complete lists of the growth stocks in Morningstar’s database.
  • Investors can use the Morningstar Investor screener to more easily compare growth stocks with each other. One way would be to screen by Stock Style under the Criteria drop-down menu, choosing large growth, mid-growth, small growth, or some combination thereof. Then once you have your results, click on Data & Columns to select Financials data points in the Stocks area. These might be valuation metrics like price/earnings ratios or revenue growth, among others. Then click Update. Once back to the list of stocks, click on the data point that matters most to you to rank the list on that particular data point.
  • Those who’d like to focus on high-quality yet undervalued growth stock picks can check out our list of the 10 Best Growth Stock to Buy for the Long Term.

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