Investing in Dividend-Paying Small Caps with Strong Balance Sheets: A Wall Street Transcript Interview with Jay S. Kaplan, a Portfolio Manager and Principal for Royce & Associates, LLC, Investment Adviser to The Royce Funds

Wall Street Transcript

67 WALL STREET, New York - April 15, 2014 - The Wall Street Transcript has just published its Investing Strategies Report. This special feature contains expert industry commentary through in-depth interviews with professional Money Managers. The full issue is available by calling (212) 952-7433 or via The Wall Street Transcript Online.

Topics covered: Dividend-Paying Stocks - Capital Appreciation - Small Cap Investing - Upside in Small-Cap Stocks - Investing Through Construction Trends - Dividend-Paying Small Caps - MLP Investing - Global Macro Trends

Companies include: Buckle Inc. (BKE), American Eagle Outfitters Inc. (AEO), Abercrombie & Fitch Co. (ANF), Aeropostale Inc. (ARO), Helmerich & Payne Inc. (HP), Nu Skin Enterprises Inc. (NUS), GameStop Corp. (GME), Sony Corporation (SNE), Microsoft Corporation (MSFT) and many others.

In the following excerpt from the Investing Strategies Report, an experienced small cap value portfolio manager discusses his investing methodology and current top picks for investors:

TWST: Can you start with an overview of the investment philosophy and strategy for the Royce Dividend Value Fund?

Mr. Kaplan: Royce Dividend Value Fund is focused primarily on dividend-paying companies with market caps up to $5 billion. We have three primary selection criteria, which are a strong balance sheet, a quality business and an attractive valuation. Let me talk about each one of those briefly.

We're in the small-cap business, which almost by definition is a risky asset class. One of the ways we try to take that risk level down a bit is to only invest in companies with strong balance sheets. That's our number-one starting point, and that has kept the firm and its investors out of a lot of trouble for a very long time. We try to avoid the zeros the small-cap world is often fraught with. So we start with impeccable balance sheets.

Number two, we're looking for high-quality companies. One of the ways we think you can find quality is by looking at the returns a business generates. We focus on return on invested capital and return on assets, so we're typically investing in businesses that have above-average returns. We think that's a good proxy for quality. We want a business that over time can generate those kinds of returns and in some way, shape or form has a better mouse trap.

Number three of course is the ultimate return, which is a function of the price that we pay. We tend to be very deliberate and careful about the prices we pay for businesses. We look at capitalization rates in the same way a real estate investor would. We define it as operating income divided by enterprise value. So if we want to own the business, how much would we have to pay to buy the entire company? How much operating income would we get for that investment? What would that return be?

In an ideal world, depending on market conditions, we'd love to buy businesses where we can get a 15% return on our money and sell them to somebody else who's willing to accept a 7% return on their money. That's the model, but the world's never ideal, and what usually happens is when you find well-capitalized, high-quality businesses they generally don't trade at discounted multiples. When they do, it's because there's some issue.

Our job is to figure out what the issue is. Is it real? Is it perceived? Is it temporary or permanent? Is it a function of the industry that the company's in? Is it a product? Is it the business itself and can it be turned around? What's the plan to turn it around? Are the right people in place to turn it around? Is the stock inexpensive enough to compensate us for taking on the risk of whatever this issue is? Hopefully, if we do it right, someday the issue goes away, the company performs again like it once did, and the valuation and the multiple go up and everyone winds up happy.

TWST: Can you give us examples of some of the fund's top holdings that exemplify this philosophy?

For more of this interview and many others visit the Wall Street Transcript - a unique service for investors and industry researchers - providing fresh commentary and insight through verbatim interviews with CEOs, portfolio managers and research analysts. This special issue is available by calling (212) 952-7433 or via The Wall Street Transcript Online.

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