Royce Investment Partners Commentary: 5 Small-Cap Value Stocks in Focus
For both the market and the economy, these are uncertain times. The much commented on last mile' of inflation is proving much more stubborn than anticipated, pushing out the possibility of interest rate cuts to May at the earliest, while the number of expected cuts in 2024 has fallen from six to three. However, if the rate of inflation does not fall far enough, the Fed has indicated that cuts may not happen this year. In addition, we are in an election year with a highly polarized electorate, which creates uncertainties of its own. Moreover, small-cap value has once again taken a back seat to small-cap growth, while the Russell 2000 Index is behind the large-cap Russell 1000 Index so far in 2024.
In this context, trying to predict which small-cap companies, industries, and/or sectors will perform well over the next 12 months, or longerwhich is always a challengeis even more difficult than usual. I find that the number of holdings in the portfolios that I manage has gone down over the last year as there are fewer attractive companies with great valuations to replace the ones that I've sold off.
With that said, I'll discuss five companies with what I think are attractive fundamentals and capable managements. I have confidence in all of them as businessesand they all trade at low to reasonable valuations and each generates ample cash, making them the kind of companies that should benefit from a more stable market and economic climate.
Shoe Carnival (NASDAQ:SCVL) is a retailer of family footwear. A long-time holding, the company is well-run, has been adding new stores for the first time in several years, and has ample cash. The company has also been putting this cash to workwisely, in my viewby making discrete acquisitions. In February 2024, Shoe Carnival bought Rogan's Shoes, a 53-year-old work and family footwear company with 28 stores spread across Wisconsin, Minnesota, and Illinois while in December of 2021, it acquired Shoe Station, which operated in the Southeast U.S. A competitor, which we also hold, has forecasted flat to lower shoe sales for the rest of 2024. This possibility puts Shoe Carnival's recent strong stock price performance at risk, but I also think that the company can weather any slowdown and would be very well positioned for a rebound. And in spite of a strong 2023, its price-to-earnings ratio was around 11.3x in mid-March, keeping its valuation attractively cheap.
Evercore (NYSE:EVR) is an investment bank whose shares did well in 2023. I like its position as a leader in mergers and acquisitions (M&A), as well as its attractive business model and healthy cash flow. Evercore also underwrites Initial Public Offerings and has a capital markets business, both of which are successful, though the M&A business accounts for the bulk of its revenue and profits. This business has been slower than usual recently but should rebound nicely in a recovery. Although its arrival is impossible to predict, I'm happy to hold what I think is an excellent business.
ePlus (NASDAQ:PLUS) is a value-added reseller of computer parts, providing hardware, software, and related services, as well as financingwhich is highly profitable. Its businesses benefit from fast-changing technology, especially with the advent of cloud computing, cyber security, and AI. So, while its businesses have remained strong, ePlus has arguably over-earned recently and saw a hiccup in its stock price earlier this year. However, I see it as a terrific picks and shovels' technology business that is worth holding over the long run.
Quanex Building Products (NYSE:NX) designs and produces energy-efficient window products in addition to kitchen and bath cabinet components. I first began to purchase shares at what I thought were attractively low prices because I see Quanex as a well-run company whose cost structure helps it generate impressive profits and ample cash in spite of a tough environment for its industry. Even after doing well in 2023, its stock trades at what I see as a reasonable valuation for a really good business.
PulteGroup (NYSE:PHM), which builds homes all over the U.S. and was a top contributor to 2023's strong performance, benefited from higher mortgage rates. Many homeowners put off selling to avoid purchasing a new home at increased rateswhich spurred demand for newly built homes for first-time home buyers. I think it's a premier company in its industry, with a management team that has a great record of effective capital allocation and is focused on shareholder returns. I also like that it builds a diverse set of homesfor entry level, move-up, and older adult buyers.
All performance information reflects past performance, is presented on a total return basis, reflects the reinvestment of distributions, and does not reflect the deduction of taxes that a shareholder would pay on fund distributions or the redemption of fund shares. Past performance is no guarantee of future results. Investment return and principal value of an investment will fluctuate, so that shares may be worth more or less than their original cost when redeemed. Shares redeemed within 30 days of purchase may be subject to a 1% redemption fee, payable to the Fund, which is not reflected in the performance shown above; if it were, performance would be lower. Current month-end performance may be higher or lower than performance quoted and may be obtained at www.royceinvest.com. Gross operating expenses reflect the Fund's total gross annual operating expenses and include management fees and other expenses. Net operating expenses reflect contractual fee waivers and/or expense reimbursements. All expense information is reported as of the Fund's most current prospectus. Royce has contractually agreed, without right of termination, to waive fees and/or reimburse expenses to the extent necessary to maintain the Investment Class's net annual operating expenses (excluding brokerage commissions, taxes, interest, litigation expenses, acquired fund fees and expenses, and other expenses not borne in the ordinary course of business) at or below 1.24% through April 30, 2024.
All performance and risk information presented in this material prior to the date of commencement of Investment Class shares on 3/15/07 reflect Service Class results. Shares of the Fund's Service Class bear an annual distribution expense that is not borne by the Investment Class.
Mr. Kaplan's thoughts and opinions concerning the stock market are solely his own and, of course, there can be no assurance with regard to future market movements. No assurance can be given that the past performance trends as outlined above will continue in the future. The performance data and trends outlined in this presentation are presented for illustrative purposes only. Past performance is no guarantee of future results. Historical market trends are not necessarily indicative of future market movements.
This article first appeared on GuruFocus.
