article 07-07-2015

What kind of a small-cap world are we living in?

In a world where performance in the equity markets, especially for the small-cap Russell 2000 Index, is growing increasingly narrow (think of small-cap biotech, which is up more than 30% year-to-date through 6/30/15), I was struck by the chart, shown below, courtesy of our friends at Furey Research Partners.

Russell 2000 Return by EBIT (as of 6/30/15)


Source: Furey Research Partners

From our perspective, it shows in the most direct way possible a trend that has stymied the best efforts of active managers such as ourselves over the last several years—specifically that the small-cap market has been led to new highs by companies with negative EBIT (also referred to as operating profit or operating income).

The majority of companies with no operating earnings or profit can be found in the biotech and, to a lesser extent, software and services industries.

Simply put, company fundamentals matter—they cannot be ignored and, we believe, this trend cannot last.

Important Disclosure Information

Francis Gannon is Co-Chief Investment Officer and Managing Director of Royce & Associates, LLC, investment adviser to The Royce Funds. Mr. Gannon's thoughts and opinions expressed in this piece are solely his own 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.

Russell Investment Group is the source and owner of the trademarks, service marks, and copyrights related to the Russell Indexes. Russell® is a trademark of Russell Investment Group. The Russell 2000 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. Frank Russell Company is the source and owner of the Russell Index data contained or reflected in this material and all trademarks and copyrights related thereto. The performance of an index does not represent exactly any particular investment, as you cannot invest directly in an index.

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