What Kind Of A Small-Cap World Are We Living In? by The Royce Funds

In a world where performance in the equity markets, especially for the small-cap Russell 2000 Index, is growing increasingly narrow (think of small-cap biotech, which is up more than 30% year-to-date through 6/30/15), I was struck by the chart, shown below, courtesy of our friends at Furey Research Partners.

Russell 2000 Return by EBIT (as of 6/30/15)

Small-Cap

Source: Furey Research Partners

From our perspective, it shows in the most direct way possible a trend that has stymied the best efforts of active managers such as ourselves over the last several years—specifically that the small-cap market has been led to new highs by companies with negative EBIT (also referred to as operating profit or operating income).

The majority of companies with no operating earnings or profit can be found in the biotech and, to a lesser extent, software and services industries.

Simply put, company fundamentals matter—they cannot be ignored and, we believe, this trend cannot last.