The Small-Cap Guru Bought These 3 Stocks


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Like many cash-strapped investors just starting out, I was convinced I could "maximize" my tiny investment account by dipping my toes into the micro-cap end of the stock market pool.

Did it make me a millionaire overnight?

Put gently: not even close.

I was left with a dwindling account balance and worthless shares of companies that had long-since imploded.

In the investing world, we call the sacrifice of those beginner funds a "grudge" account. I prefer to think of it as tuition paid into an investing career that would live on much longer than most of the stocks I traded back then.

Although my initial investments were long-gone, one thing that did remain was a passion for finding healthy companies with smaller capitalizations and real business plans.

Fortunately, there are some real gurus in this space -- one, in particular, reigns as king.

Chuck Royce, of Royce & Associates, has over four decades of experience in capital markets, making a name for himself in primarily small-cap investing.

His methodology seems simple: find stocks that are relatively undervalued with low debt and above-average returns.

The Royce Funds manage about $38 billion today, keeping their focus on micro-, small-, and mid-cap companies. The firm's definition of a small-cap is between $750 million and $2.5 billion. For the purposes of my screen, I bumped up the low end to $1 billion to try and increase the safety factor.

Out of the 102 new purchases the fund made this past quarter, I've singled out the three that received the biggest investments from Royce & Associates and met my small-cap cutoffs.

Civeo Corp. (NYSE: CVEO ) may ring a bell for some of my astute readers. I covered the workforce lodging company in early July as one of Jana Partner's new energy-related plays.

Royce's $37.5 million position is a fraction of Jana Partner's, but both are in good company. Billionaires David Einhorn and David Shaw also snagged $213.5 million worth of CVEO, collectively.

Why is CVEO so popular among gurus? Many are betting that CVEO will be converted into a real estate investment trust (REIT) soon. The change would mean CVEO has to pay at least 90% of its taxable income to shareholders. Expect that unlocked value to pad some portfolios nicely if the conversion goes through.

Generic drug maker Lannett Company, Inc. (NYSE: LCI ) earned a $16.8 million investment from Royce last quarter. If you don't have an iron stomach, I would not mirror his move - "volatile" is the best way I'd describe LCI's trading so far this year.

Pharmaceutical stocks with smaller caps are usually subject to wild swings due to FDA approvals/rejections, smaller catalogues of products and extensive R&D expenses.

In LCI's case, a July subpoena from the Connecticut Attorney General claiming antitrust violations is enough to keep me away. Lannett says it complies with all laws and plans to cooperate fully; I'd park my capital elsewhere though, just to be on the safe side.

Paylocity Holding Corp. ( NASD: PCTY ) was Royce's third-largest new small-cap position, receiving nearly $15 million. Using an innovative cloud-based approach, PCTY provides payroll services for growing businesses.

Paylocity IPO'd in March at $17 and has run up 34% since. But August earnings revealed a net loss for fiscal year 2014. My pick in the same space would have to be Paycom Software, Inc. (NYSE: PAYC ) , which has already bested PCTY on earnings and revenue for the past two quarters. Watch for a pullback, though, as PAYC is up nearly 30% since the beginning of August.

Risks to consider: Small-caps carry their own specific risks. Metrics like P/E ratios and book values do not hold the same weight as they do with more established companies. You may also find that analyst commentary is hard to come by, so keep that in mind before diving in.

Action to take--> Stocks with smaller capitalizations can be a gold mine for investors looking to find the next big thing - as long as they can stomach the risk. Out of this round of Royce's latest picks, I'd take a deeper look at CVEO while staying on the sidelines for LCI and PCTY.

If the risk of small-cap stocks scares you, how about a few investments in stocks that will likely never fail ? I'm talking about "Forever" stocks - companies so strong that you can literally buy shares, forget about it and hold that position forever. These are the best, most profitable companies in the world. To learn the name and ticker symbols of some of these companies, click here .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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This article appears in: Investing , Investing Ideas , Stocks

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