Growth stocks, as measured by the Russell 2000 Growth index, fell more than 40% from their 2021 highs to their 2022 lows, victims of the largest and swiftest increase in interest rates in decades. But that doesn’t mean investors should give up on finding promising growth companies, even as central banks continue to raise rates to tame inflation.

Barnaby Wilson, a London-based managing director and portfolio manager at Lazard Asset Management, takes a tailored approach to growth-stock investing, focusing on companies that produce cash-flow returns on investment at a low- to midteens percentage rate. His favorite companies are capital-light, meaning they don’t need to invest large sums in heavy equipment. Wilson and his team value companies on a discounted-cash-flow basis, investing only in those that sell at a discount to their public market value. The team also looks for companies with a competitive moat.

Among his other roles at Lazard, Wilson co-manages the Lazard International Quality Growth Portfolio (ticker: OCMPX), a $138 million fund rated four stars by Morningstar. [Morningstar published an updated rating shortly after this article was published. It now rates the fund five stars.] The fund, launched in 2018, has outperformed its category in three of the past four years, and posted a total return of negative 20% last year, versus a category average of negative 25%. International Quality Growth is up 4.5% this year through March 1.

Barron’s spoke with Wilson on Feb. 7, and in follow-up conversations, about the outlook for growth stocks, his investment approach, and some of his favorite stocks. An edited version of the discussion follows.

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Barron’s: Barney, you wear many hats at Lazard. Describe your job.

Barnaby Wilson: I am co-lead manager with Louis Florentin-Lee of several funds, including Lazard International Quality Growth. We have both been at Lazard for about 20 years, and have been working together formally on this strategy since the start of 2016. We strive to identify companies with the characteristics we like.

For us, quality means companies that are able to sustain high levels of financial productivity. How well do they use the assets at their disposal to generate profits and cash for shareholders? A key metric for us is cash-flow return on investment. The financial productivity of the companies in our portfolio tends to be double that of the broader market.

Even quality growth stocks had a poor year in 2022 as the Federal Reserve and other central banks raised interest rates. What is the case for sticking with them now?

Plenty of traditional growth companies generate a lot of revenue growth but low levels of profit. Investors expect them to grow into profitable businesses at some point in the future. Quality stocks are different: They deliver a high level of profitability today. Our analysis shows that high-quality stocks can outperform the broader market over time, in both value and growth markets. Our premise is that, rather than trying to time shifts by tilting to value or growth, just stick with high-quality businesses, and let them do the work of coping with whatever is going on in the environment.

Have you been an active buyer of stocks this year—and if so, where?

Our annual turnover typically has been in the 10%-15% range, and really hasn’t changed much over time. There is no pattern to our buying by sector or geography. We bought a company in Japan within the past year that has businesses in the semiconductor and healthcare spaces. We bought a company in Europe that produces automation systems for warehouses. We bought another European company that produces equipment used in the manufacture of biologic drugs. There is a big shift under way from small-molecule drugs to biologics. Growth in the biologics area is well in excess of the broader healthcare average.

Your fund is international, as well as growth-oriented. Are non-U.S. stocks poised to outperform the U.S. market?

There are reasons to think that non-U.S. markets might finally be about to outperform the U.S. If you look hard enough in international markets, you can find wonderful businesses that, in many cases, have a level of financial productivity that would put them in the top tier, even including U.S. companies. They trade at somewhat more attractive valuations than similar businesses in the U.S. That is an opportunity for U.S. investors.

Although the global economy is still strong, economists expect a recession later this year or next year. How do you protect the fund from recessions?

Historically, high-quality businesses have tended to defend against volatility in difficult markets and economic environments. In a recessionary environment, in particular, pricing power is important. We wouldn’t expect to see these companies experience a significant drop in volume in a recession, and if they can maintain pricing power, we would expect their profits to fall less than those of the broad market.

ASML Holding [ASML] is one of your top positions. Why do you consider it a quality growth stock?

ASML is based in the Netherlands. It makes semiconductor-manufacturing equipment, and dominates in photolithography, a critical manufacturing step. For a long time, the industry was a duopoly controlled by ASML and a company in Japan. But ASML has been able to spend significantly more than its competitor in the past 15 years on research and development of newer generations of its machines.

Coming out of the financial crisis of 2008-09, ASML’s biggest customers took an equity stake in the company precisely to ensure that it could continue to spend to develop next-generation equipment. As a result, ASML is the only company in the world with its lithography technology, and customers have little choice but to buy its machines to perform this critical manufacturing step.

Unilever [UL], the consumer-staples company, is another large Quality Growth fund holding. What is the attraction?

Unilever, based in London, has high financial returns as a result of the stable of brands it has built up through the years. These branded businesses are good examples of businesses with pricing power. In the past few years, the company has done a good job of passing on to customers the input-cost inflation it has faced. Also, Unilever has a high exposure to emerging markets, where demand typically is growing faster than in developed markets. More than 50% of its revenue is coming from emerging markets.

Second, the company is exposed to some attractive end-market categories, particularly in personal care and beauty-type products that should grow faster than the overall market. Personal care, beauty, and well-being are likely to be the most exciting categories for Unilever over the long run, while home care and nutrition products might grow more slowly. This is where the emerging markets exposure comes in: As people get wealthier, they want to be able to access more sophisticated products. As that happens, companies “premiumize” their offerings and expand their growth margins. Then, they are able to reinvest in product development and marketing, creating a kind of virtuous circle.

How do you value Unilever’s growth potential?

We estimate that Unilever needs to sustain its current level of financial productivity and growth for around eight years to justify the current market capitalization of around $125 billion. We are reasonably confident that its strong brands and the growth opportunities in its categories and geographic markets will allow the company to deliver strong financial productivity and growth for longer than that. Hence, we feel the stock is undervalued.

What else looks attractive to you?

RELX, formerly known as Reed Elsevier, is also based in London, and has a variety of competitive advantages that will allow it to sustain high levels of financial productivity. The company is one of the biggest publishers of academic journals that are leaders in their fields. Scientists, engineers, and researchers want to read these journals and be published in them. The prestige of these publications is a competitive advantage and creates a strong barrier to entry.

Somewhat similarly to Unilever, this isn’t the fastest-growing business in the world, but it has some growth potential. As science and research projects grow, there is more publishing to be done, and the business will continue to grow.

What is the financial outlook for RELX?

Top-line growth in academic publishing is pretty stable in the low-single digits. The business isn’t particularly economically sensitive, which is an attraction in a market that might see more volatility in coming years. There is room for some margin expansion as the company continues to harvest efficiencies of scale and introduces products that help users access data embedded in scientific research. The business has moved from a traditional model of just selling print journals to an online-subscription-based, data-driven business over the past 20 years, and the process is ongoing. In a normalized environment, we would expect to see low-double digit earnings growth.

How much upside do you see for ASML, Unilever, and RELX?

We don’t have target prices for these stocks and don’t focus on forward price/earnings multiples. We start with the current market cap, and then try to work out—in years—the financial productivity and growth that the companies would need to maintain to justify that market cap. We call this the market-implied competitive-advantage period.

We look to buy companies for which the barriers to competition will last longer than the market-implied competitive-advantage period. For these three companies, that period is somewhere between seven and nine years. In each case, we are expecting the barriers to competition—and therefore, the financial productivity and growth—to last longer than that. We don’t put a number on how long we expect the barriers to competition to last; that would imply a level of precision we don’t have. But we do think it will be more than 10 years in each case.

Thanks, Barney.