In a recent interview with Barron’s, veteran stock picker Chuck Royce said that active management and value investing will survive, and small-caps are headed for a rebound.
Here are highlights from the interview:
- Regarding the outperformance of large-caps in the past decade, which Royce characterizes as a “megacap bubble”, he anticipates “growing investor disenchantment” with large companies that are generating persistent losses, “which could be a catalyst for increased interest in the opposite—small-caps with proven business models and real earnings.”
- Low interest rates, Royce argues, have depressed value performance and “expanded the multiples of growth stocks.” He notes that price-to-book, once a dependable metric, may no longer be as useful since the world has shifted toward “asset-light and services-oriented economies.” Royce prefers to focus on return-on-assets, cash flow and cash flow yield.
- “We are looking for growing companies that can compound at a reasonable number,” says Royce, adding, “quality is a secret weapon. Companies with intellectual capital imbedded in their products, which deliver productivity and automation benefits to their customers, is where we see undervalued quality situations today.”
- On increased corporate debt levels, Royce says the concerns may be overblown: While low rates may have “allowed zombie companies with a lot of debt to stay in business much longer than should have been the case,” Royce notes that it’s interest coverage (which is on par with historical levels) that matters, not leverage. “You go broke by not making interest payments, not because of a high multiple of debt.”
- The China issue, says Royce, “has been with us forever. I’m not sure we are ever going to fix things.”
- “There is a high possibility of active managers in small-caps doing well,” says Royce.