Royce’s View on Small-Cap Valuations and Opportunities
article , video 06-19-2018

Royce’s View on Small-Cap Valuations and Opportunities

How did the Russell 2000 get cheaper in 1Q 2018? Francis Gannon explains.

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THINK

Where do you see overall valuations for the Russell 2000?

One of the best aspects of the market in the first quarter of this year, at least from a small-cap perspective, is that even though we saw greater volatility and lower returns, in effect what happened was the Russell 2000, the small-cap market, actually got cheaper on both the forward PE multiple and if you use a more Royce-like metric of EV-to-EBIT. At the end of the first quarter, the Russell 2000 is a cheaper index than it was at the end of 2017.

What do investors often miss about the small-cap index?

So one of the things investors miss about the small-cap asset class is the great dispersion with the index itself.  So within the first quarter of this year, you had an index class from a cap-weighted standpoint was basically flat down slightly. And yet from an equal-weighted standpoint was actually down 2.5%.  So there was great dispersion within the overall index, and good active managers are able to take advantage of that dispersion within the index and find opportunity. 

Where do you see greater opportunity?

So last year earnings ended the year at roughly up 8% year-over-year. Expectations for small-cap earnings this year at up almost 25%, so a significant increase. Obviously generated by the corporate tax cut we saw that went into play at the beginning of this year.  So the numbers have expanded enormously, which is also helping in terms of overall valuation within the market. 

Within that expectation of where we’re going to see opportunity within the market this year from an earnings perspective, I think you're going to see it driven more by companies that are benefiting from a stronger economic environment domestically, as well as outside of the United States. You seem to be in this synchronized economic expansion at the moment and that is a good thing from an earnings perspective. 

Many companies in our company meetings are talking about things improving and they remain cautiously optimistic.  But in that environment, the more economically sensitive cyclical areas are really benefiting from this strength, and yet the market didn't focus on them during the first quarter of the year. We continue to think that that's a great place for investors to find opportunity going forward.

Important Disclosure Information

The thoughts and opinions expressed in the video are solely those of the persons speaking as of April 9, 2018 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. Past performance is no guarantee of future results.

The performance data and trends outlined in this presentation are presented for illustrative purposes only. All performance information is presented on a total return basis and reflects the reinvestment of distributions. Past performance is no guarantee of future results. Historical market trends are not necessarily indicative of future market movements.

Frank Russell Company (“Russell”) is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell® is a trademark of Frank Russell Company. Neither Russell nor its licensors accept any liability for any errors or omissions in the Russell Indexes and / or Russell ratings or underlying data and no party may rely on any Russell Indexes and / or Russell ratings and / or underlying data contained in this communication. No further distribution of Russell Data is permitted without Russell’s express written consent. Russell does not promote, sponsor or endorse the content of this communication. The Russell 2000 Index is an unmanaged, capitalization-weighted index of domestic small-cap stocks. It measures the performance of the 2,000 smallest publicly traded U.S. companies in the Russell 3000 Index. The performance of an index does not represent exactly any particular investment, as you cannot invest directly in an index.

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