The Case for Small-Cap and 4 Key Holdings —Royce  
article 01-07-2025

The Case for Small-Cap and 4 Key Holdings

Chuck Royce and Co-CIO Francis Gannon look at the promising forecast for small-cap earnings and discuss 4 high-conviction companies.

TELL US
WHAT YOU
THINK

Were you surprised by the market's increased volatility through the last six weeks of 2024?

Francis Gannon: Somewhat, yes, if only because December has so often been a positive month. Think of how often we hear the phrase “Santa Claus rally” near the end of most years. Stocks had been on quite a tear going into the last full week of November—and really for the last two years. In fact, large-caps hadn’t posted two consecutive years of 20%-plus performance since the late ‘90s—a period of large-cap dominance that presaged a long period of small-cap leadership. From 1999 through 2010, the Russell 2000 Index beat the large-cap Russell 1000 Index in eight of 12 calendar years.

How did performance shake out for the year as a whole?

Chuck Royce: Small-caps trailed large-caps, with the Russell 2000 advancing 11.5% versus a gain of 24.5% for the Russell 1000. Curiously, micro-caps fared better than small-caps—the Russell Microcap increased 13.7% in 2024—and mega-caps fared better than large-caps. The Russell Top 50 Index rose 34.2%. Yet the most telling statistic from 2024 might be that small-cap trailed large-cap for the eighth consecutive year—which is a record that goes back more than 40 years to the inception of the Russell 2000 and Russell 1000 on 12/31/78. In fact, the Russell 1000 had never beaten its small-cap sibling for more than four straight years prior to 2016—and it enjoyed four consecutive years of outperformance only twice, from 1984 through 1987 and from 1995 through 1998. So we understand that small-cap investors are frustrated, even after two years of positive double-digit returns. On a relative basis, it’s been a challenging period for all of us who specialize in the asset class.

A Big Year for Large-Cap
Russell Index Returns, 12/31/23-12/31/24

 

Past performance is no guarantee of future results

Do you anticipate more volatility in 2025?

FG: We do. It’s interesting to us that these periods of lower-than-average volatility often lull investors into a sense that markets will remain placid or predictable going forward. Yet history shows very clearly that volatility always spikes sooner or later, and almost always without warning—which of course exacerbates the volatility. Over most of the last two years, volatility has been lower, as measured by the VIX—the CBOE Volatility Index, which tracks the market’s expectations for the relative strength of near-term price changes in the S&P 500 Index. With brief exceptions, such as a short-lived spike in early August 2024, large-cap stocks enjoyed an uncommonly quiet year in 2024, just as they did in 2023.

CR: Of course, small-caps were relatively more volatile than their large-cap counterparts, specifically in 2023. Within small-cap, we gauge volatility by looking at the percentage of trading days with up or down moves of at least 1%. Over the last 25 years, the Russell 2000 has averaged 42% of trading days having such moves. In 2023, 46% (or 116 out of 250 days) had moves of at least 1%. In 2024, it was 41%, or 103 out of 252 days—which made last year a slightly less volatile period than average. Whether for small- or large-cap, lower levels of volatility simply cannot persist indefinitely—which we see as a positive. We’ve never seen increased volatility through the conventional lens of fear but with the longer-range vista of opportunity. As risk-averse and price sensitive long-term investors, we welcome higher volatility and always work to use it to our long-term advantage.

Does earnings growth for small-cap still look relatively better than the prospects for large cap's earnings in 2025?

FG: Market-wide, earnings are expected to be pretty healthy, with the current consensus indicating 15% earnings per share (“EPS”) growth for the Russell 1000, along with solid to strong results anticipated for 4Q24, which will be reported in the coming weeks. Consensus EPS estimates for the Russell 2000, however, are considerably higher than they are for large-caps in 2025, coming in at an impressive 44%.

There’s some important context here: small-caps as a whole finished 2024 having endured a two-year earnings recession, so a rebound makes a certain amount of sense. It’s also important to keep in mind that more than 40% of the companies in the Russell 2000 currently have no earnings. Our own portfolios typically hold companies that have established histories of earnings or those where our respective investment teams have identified a catalyst for earnings to resume or begin.

Can you discuss a few holdings in which you have high long-term confidence?

FG: There are four companies that we hold in both our Small-Cap and Small-Cap Premier Quality Strategies that are high-confidence names from Lauren Romeo and Steven McBoyle. The first is Arcosa, an infrastructure products provider, which posted solid third-quarter results despite the negative impact of inclement weather in several of the key operating regions where it sells aggregates. The company also expanded margins thanks to its ongoing focus of exercising the pricing power associated with the local monopoly nature of the aggregates business. We think that pricing actions taken in 2024 and an expected uptick in aggregates volumes in 2025 as U.S. infrastructure spending tailwinds persist both bode well for future growth. We also think that continued strong orders in Arcosa’s Engineered Structures segment—for example, rising utility spending on transmission and wind towers to meet higher load growth—are also promising for organic growth. Finally, Arcosa closed on its acquisition of Stavola, a leading aggregates and asphalt provider in the Northeast, which gives the company entry into a new geographic market with a high degree of less cyclical repair and replace spending that’s related to infrastructure.

Arcosa (NYSE: ACA)
12/29/23-12/31-24

 

Past performance is no guarantee of future results

ESAB Corporation is a global leader in fabrication technology for both welding equipment and consumables. It serves the broad and growing need for global infrastructure requirements while operating in a favorable oligopoly marketplace. Spun out from the public company Colfax in 2022, ESAB is somewhat new to the public markets and has embarked on a transformational journey of product innovation, streamlined operational efforts, new channel strategies, and footprint rationalization, all while being a price leader in its markets. In October, management reported strong results, with double-digit equipment growth—which was particularly impressive considering that 40% of its sales are tied to U.S. industrial activities—along with further pricing gains, geographic share gains, and continued margin improvement. The market appears to be recognizing ESAB’s significant transformation, as well as its product mix, product innovation, and the geographic expansion opportunities that lie ahead.

ESAB Corporation (NYSE: ESAB)
12/29/23-12/31-24

 

Past performance is no guarantee of future results

The third name is Haemonetics, a long-time holding that’s the dominant provider of plasma collection systems, consumables, and software. It’s continuing to meet estimates as it navigates phasing out of a large customer and challenging plasma volume comparisons. Despite revenue pressure, the company delivered on its goal of improving operating margins via a business mix shift and share gains, as well as its Hospital-based segment increasing its contribution to profits. The company’s core vascular closure product continues to grow nicely, while a newly introduced larger closure product is seeing high usage even as it awaits an FDA label expansion, as it benefits from the rapid adoption of Pulsed Field Ablation to treat atrial fibrillation.

Haemonetics Corporation (NYSE: HAE)
12/29/23-12/31-24

 

Past performance is no guarantee of future results

The fourth is JBT Marel (“JBTM”), one of the world’s largest providers of food and beverage processing machinery. It also reported terrific 3Q24 results, which drove its shares higher in late October. Sales grew by 12%, EBITDA margins rose by 160 basis points, and free cash flow is on pace to exceed 100% of net income for the year. Equally promising was a 10% rise in orders, which showed strength not just from a rebound in demand in the global poultry market, but also strength in food and vegetables, pharmaceuticals, and pet food. Orders grew in all geographic regions, in part reflecting long-term drivers such as automation to improve efficiency and reduce labor costs. JBTM also continues to generate a high percentage of recurring revenue, with 47% of sales coming from parts and services from its broad installed base of equipment, which provides a consistent cash flow stream. Finally, JBTM closed on its acquisition of Marel (an Iceland-base food and beverage equipment company focused on primary processing) during the first week in 2025. The acquisition should enable JBTM to realize significant cost synergies and cross-selling opportunities going forward.

JBT Marel (NYSE: JBTM)
12/29/23-12/31-24

 

Past performance is no guarantee of future results

What is your outlook for active small cap management going forward?

FG: We realize that people may be a little tired of hearing it, but we feel very good about the prospects for small-cap leadership in 2025—and our optimism is even higher for active small-cap leadership. The very promising earnings prospects are a major factor in our thinking, of course, but our conviction becomes even stronger when combined with small-cap’s far more attractive valuations compared to large-cap. Using our preferred index valuation metric of enterprise value over earnings before interest and taxes—or EV/EBIT—we see that the Russell 2000 finished 2024 still near its lowest levels relative to the Russell 1000 in 25 years. To us, this combination signals an ongoing opportunity for active small-cap managers to capture robust earnings growth at attractive—highly attractive in many cases—prices. Recent underwhelming relative performance has not made us any less confident in the long-term case for small-cap leadership.

Important Disclosure Information

Average Annual Total Returns as of 12/31/2024 (%)

  QTD1 1YR 3YR 5YR 10YR SINCE
INCEPT.
DATE ANNUAL
OPERATING EXPENSES
NET               GROSS
Capital Micro-Cap 4.97 13.67 1.55 11.00 7.28 9.72 12/27/96  1.18  1.18
Capital Small-Cap -2.01 3.40 5.74 7.18 5.63 9.60 12/27/96  1.15  1.15
Dividend Value 2.57 19.62 8.29 9.77 8.74 8.96 05/03/04  1.34  1.61
Global Trust -3.50 14.81 -4.18 5.57 7.21 5.55 10/17/13  N/A  N/A
Global Trust (NAV) -2.36 11.80 -1.78 5.69 7.40 6.23 10/17/13  N/A  N/A
International Premier -9.42 -7.36 -10.13 -2.34 5.28 4.56 12/31/10  1.44  1.61
Micro-Cap 4.97 13.37 1.56 11.31 7.51 10.54 12/31/91  1.24  1.25
Micro-Cap Trust 3.70 14.17 3.37 11.89 9.14 10.20 12/14/93  N/A  N/A
Micro-Cap Trust (NAV) 3.53 13.47 3.23 11.86 9.16 10.74 12/14/93  N/A  N/A
Premier -3.33 2.97 2.17 6.71 8.60 10.99 12/31/91  1.19  1.19
Small-Cap -1.81 7.07 4.00 9.38 8.83 N/A N/A  0.94  0.94
Small-Cap Opportunity 3.65 10.30 3.03 12.61 9.78 11.84 11/19/96  1.23  1.23
Small-Cap Special Equity -0.29 3.05 2.88 7.46 6.16 8.40 05/01/98  1.22  1.22
Small-Cap Total Return 4.10 10.03 5.80 9.11 8.29 10.26 12/15/93  1.26  1.26
Small-Cap Trust 3.55 18.13 1.29 10.49 9.95 9.95 11/26/86  N/A  N/A
Small-Cap Trust (NAV) 0.58 12.64 2.57 9.54 9.37 10.38 11/26/86  N/A  N/A
Small-Cap Value -2.01 3.25 5.40 7.03 5.68 8.62 06/14/01  1.49  1.62
Smaller-Companies Growth 5.97 21.84 -1.22 9.17 8.09 10.43 06/14/01  1.49  1.57
Russell Microcap
5.89 13.70 -1.00 6.97 6.77 N/A N/A  N/A  N/A
Russell 2000
0.33 11.54 1.24 7.40 7.82 N/A N/A  N/A  N/A
Russell 2000 Value
-1.06 8.05 1.94 7.29 7.14 N/A N/A  N/A  N/A
Russell 2500
0.62 12.00 2.39 8.77 8.85 N/A N/A  N/A  N/A
MSCI ACWI SC
-3.26 7.66 0.76 6.68 7.26 N/A N/A  N/A  N/A
MSCI ACWI x USA SC
-7.66 3.36 -1.47 4.30 5.66 N/A N/A  N/A  N/A
Russell 2000 Growth
1.70 15.15 0.21 6.86 8.09 N/A N/A  N/A  N/A
1 Not annualized.

This material is not authorized for distribution unless preceded or accompanied by a current prospectus. Please read the prospectus carefully before investing or sending money. The performance data and trends outlined in this article 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. Investments in securities of micro-cap, small-cap, and/or mid-cap companies may involve considerably more risk than investments in securities of larger-cap companies. (Please see "Primary Risks for Fund Investors" in the prospectus.) Investments in foreign companies may be subject to different risks than investments in securities of U.S. companies, including adverse political, social, economic, or other developments that are unique to a particular country or region. (Please see "Investing in International Securities" in the prospectus.)

Mr. Royce’s and Mr. Gannon’s thoughts and opinions concerning the stock market are solely their 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. 

Percentage of Fund Holdings As of 12/31/24 (%)

  Small-Cap Capital Micro-Cap Capital Small-Cap Global Trust International Premier Micro-Cap Micro-Cap Trust Small-Cap Trust Premier Small-Cap Special Equity Small-Cap Total Return Small-Cap Value Smaller-Companies Growth Small-Cap Opportunity Dividend Value

Arcosa

2.0

0.0

0.0

1.5

0.0

0.0

0.0

1.0

3.1

0.0

0.0

0.0

0.0

0.0

0.0

ESAB Corporation

1.0

0.0

0.0

2.0

0.0

0.0

0.0

0.8

2.6

0.0

0.0

0.0

0.0

0.0

0.0

Haemonetics Corporation

1.3

0.0

0.0

0.0

0.0

0.0

0.0

1.0

2.3

0.0

0.0

0.0

0.0

0.0

0.0

JBT Marel

0.9

0.0

0.0

0.0

0.0

0.0

0.0

0.8

2.9

0.0

0.0

0.0

0.0

0.0

0.0

Company examples are for illustrative purposes only. This does not constitute a recommendation to buy or sell any stock. There can be no assurance that the securities mentioned in this piece will be included in any Fund’s portfolio in the future.

Sector weightings are determined using the Global Industry Classification Standard ("GICS"). GICS was developed by, and is the exclusive property of, Standard & Poor's Financial Services LLC ("S&P") and MSCI Inc. ("MSCI"). GICS is the trademark of S&P and MSCI. "Global Industry Classification Standard (GICS)" and "GICS Direct" are service marks of S&P and MSCI.

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. All indexes referenced are unmanaged and capitalization weighted. The Russell 2000 Index is an index of domestic small-cap stocks that measures the performance of the 2,000 smallest publicly traded U.S. companies in the Russell 3000 Index. The Russell 1000 Index is an unmanaged, capitalization-weighted index of domestic large-cap stocks. It measures the performance of the 1,000 largest publicly traded U.S. companies in the Russell 3000 Index. The Russell 2000 Value and Growth indexes consist of the respective value and growth stocks within the Russell 2000 as determined by Russell Investments. The Russell Top 50 Index measures the performance of the largest companies in the Russell 3000 Index. It includes approximately 50 of the largest securities based on a combination of their market cap and current index membership and represents approximately 40% of the total market capitalization of the Russell 3000 Index. The S&P 500 Index tracks the stock performance of 500 of the largest companies listed on stock exchanges in the U.S. The performance of an index does not represent exactly any particular investment, as you cannot invest directly in an index.

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