How Does This Royce Portfolio Manager Find New Ideas?
article , video 09-29-2017

How Does This Royce Portfolio Manager Find New Ideas?

Portfolio Manager Jay Kaplan discusses how he builds his portfolios and the lessons he has learned throughout his career.

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How does a new idea get into the portfolio?

There are lots of ways that I find new ideas. One of the basic ways is by running a screen. We have some elegant software that does this. Anybody sitting at home at their PC can do the same thing without the elegant software. It's all on the internet and it's pretty easy to do today.

But find some criteria that you think you like, and we have some, we've used them for a while. We think about balance sheets, we think about returns on capital, we think about valuations. You take your universe, you have to put it through the big funnel, and you get a list. And that's screening.

And most professional investors do some degree of screening. When you're a value investor and you're looking for out of favor ideas, and you do screening, you'll get a list. A lot of what's on the list is not really investable. There are value traps and they're cheap, they deserve to be cheap, and you want to stay away. So great tool, not the only tool. News flow, very important.

Companies that are in the news are a good source of ideas. Companies that we have invested in in the past, when they come up in the news, when there have been changes in their business, when they hiccup, we love hiccups. Good companies we've had success with, when there are hiccups, they come right back on the plate for us to take another look.

So those are some of the ways that we can find ideas.

How do you work through the list of new ideas?

I try and prioritize new ideas. Sometimes there are names I haven't looked at before. Sometimes there are old favorites. And we try to think about what might be a good first prospect.

So the first thing I'm going to do usually is take a quick look at the numbers. And see if the numbers make sense. See if the numbers fit what I'm trying to do.

After that we start to dig in. So I'll look at earnings releases, financial statements, news stories, conference call transcripts, to try and figure out what the business is, the industry, the background.

We're trying to get to the critical issues about what’s the problem here? When you're a value investor and you're looking for high quality inexpensive stocks, they're usually inexpensive because there's a reason, because there's an issue.

What is that issue? How bad is it? How solvable is it? How long might it take? And at the end of the day, are you getting paid to take on that risk? So we'll do that.

And then we'll look around the firm and see if there's somebody else who maybe has more recent experience with the stock than I do. So, can I look to some of my colleagues to get a little help? And in many, many circumstances, somebody here has some knowledge.

So now we want to dig into Wall Street research and try and figure out what does the consensus think about the issues, and is the consensus right or is the consensus wrong? Sometimes we have a difference of opinion. That's where we can get to the real good opportunities.

What are you doing differently now than you were earlier in your career?

I've been at this for a while. And I've changed, I've gotten more experience. The industry has changed. In the old days, I relied a lot more on Wall Street than I do today. But in today's world, my reliance on the street is much less. Another big change with experience is, you're really able to distill information, cut through the clutter, and cut through the noise very quickly, and get to the point, and figure out what's important, and figure out what will or won't make an investment work. And I can do that pretty quickly now. That comes from experience.

In the old days I would go on a lot of plant trips, I went to every conference for days and days at a time, to learn as many companies as I could. Well I know a lot of companies, so I don't do that as much anymore. I'm a lot more focused on what I do today. I have more patience than I used to have. That comes with age, I suppose.

I could be more thoughtful and decisive in what I do than when I was younger. So I think a lot of things, like wine, to be cliché, get better with age.

What do you pay less attention to and what do you pay more attention to now?

I started in business in fixed income. I was a lender and a bond guy. Bond people spend an awful lot of time thinking about balance sheets and cash flow. When I moved into the equity world, I discovered that in the equity business the orientation was a lot different. It was about P/E ratios, and earnings growth rates, and beating the estimates, or missing the estimates.

And my focus pivoted toward that. Over time I've started to go back to cash flow. I think if you follow the cash, you can follow the creation of value. It's the cash flow that really counts.

Early on I thought that meeting with management teams was very important, and it still is today. But it's important for a different reason. Back then I thought you needed to really know the people, and have a dialogue with the people, so that they would pick up the phone and answer your questions. And that's all well and good. And that still happens now.

But it's really more than that. It's about track record, and comfort, and meeting folks, having them tell you about what their plans are, how they're going to execute against their plans, and then meeting with them again and measuring their performance against what they told you the last time. So there are patterns. And that's much more important than just having dinner with somebody. So that's been a big, big change.

Important Disclosure Information

The thoughts and opinions expressed in the video are solely those of the person speaking as of July 12, 2017 and may differ from those of other Royce investment professionals, or the firm as a whole. There can be no assurance with regard to future market movements.

This material is not authorized for distribution unless preceded or accompanied by a current prospectus. Please read the prospectus carefully before investing or sending money. Smaller-cap stocks may involve considerably more risk than larger-cap stocks. (Please see "Primary Risks for Fund Investors" in the prospectus.)

 

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