Royce Funds Portfolio Manager Jim Stoeffel talks about his investment criteria, what he looks for in management teams, how he tries to avoid value traps, and Royce’s approach to building conviction.
Francis Gannon: So, in describing yourself as an investor, you talk about the importance of growth, especially to help you stay out of value traps. Could you go into that a little bit more?
Jim Stoeffel: The classic value trap is the company that looks very cheap on its face, and often times it’s cheap for a reason because they’ve lost their competitive advantage. Something has changed either cyclically, on a secular basis, on a competitive basis, and, ultimately, they’re going to prove not to be cheap because there’s no growth in the business. And if you have no growth in revenues, you still have a lot of growth in your expenses because there’s inflation in the business and you’re going to start deleveraging the operating model, and eventually the numbers are going to prove much lower than you thought.
So if you have at least a little bit of growth there to keep the ball moving, I think it takes some of that risk out of it. The candid truth of the matter is even though we’re value investors, everyone’s looking for some growth because it’s an indication of a healthy business. The question just becomes, “What do you pay for it?”
Francis: So when you talk about the things you’re attracted to in a company, you’ve talked about the balance sheet, you’ve talked about the importance of returns. What are the other key criteria that you’re looking for?
Jim: Well, clearly it’s management. Every investment that a small-cap company makes is typically pretty critical to the enterprise because of the size of the enterprise. The key is really having management teams that can actually execute against the strategy.
It goes back to the Royce concept of building conviction. You want to see management teams, you want to hear what they have to say. Over time you can build the conviction that they do know what they’re doing. They do know how to allocate capital, and that’s very critical because we’ve seen plenty of companies that don’t allocate capital quite so well.
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