Video Transcript:
our positive outlook for the new year
Hi, I’m Will Nasgovitz. It’s great to be joining you here again to kick off 2012. We want to start this year by addressing some important topics, we believe, as it relates to investing in small cap companies. I’ve always had a passion investing in small caps. Heartland has historically had exposure to small cap companies. We believe it’s a great place to find compelling valuations as a value investor. But, small caps, as you can see in this chart, got beat up pretty badly last year, and our exposure to small caps hurt our performance.
Russell 2000 Index Market Cap Quintile: 12/31/10 – 12/31/11
Past performance does not guarantee future results.
Source: FactSet Research Systems, Inc.
That said, we remain confident in the holdings that we have in the small cap universe today. Here is why. Most notably, we’re very intrigued by the valuations we’re finding in small cap stocks today, in particular on a Price to Book Value Ratio. Book Value is essentially the company’s net worth. So you take all of the company’s assets - cash, inventory, accounts receivable, property and equipment less the company’s liabilities. Liabilities would include accounts payable and a company’s debt.
Russell 2000 Value Index - Price to Book Ratio
Past performance does not guarantee future results.
Source: Bloomberg, 12/29/1995 to 12/31/2011.
And, as you can see in this chart, small cap stocks are at historically low multiples relative to their Book Value. So we believe this suggests that there is also limited downside risk as the companies are already trading at historically low multiples of book value. We also want to revisit a chart that we showed you last November which walked through the poor performance of the Russell 2000 in the third quarter of last year.
Worst Quarters for the Russell 2000
Past performance does not guarantee future results.
Source: Credit Suisse Small & Mid Cap US Equity Strategy, Bloomberg, 12/31/1978 to 12/31/2011.
*Forward Year Returns represent the annualized return one year after the respective worst quarter above.
That was the fourth worst quarter for small cap stocks on record as measured by the Russell 2000, and what we pointed out was that, historically, small cap stocks post positive returns in a subsequent quarter and subsequent year. We are reassured by the performance of small cap stocks in the fourth quarter of 2011. The Russell 2000 posted a positive 15.47% return in the fourth quarter.
So, while the outlook for equity investing remains unsettled, we are encouraged by valuations in small caps as measured by Price to Book and also by the historical precedent for positive returns following quarters of underperformance. Thanks for watching. Happy 2012 and we look forward to visiting with you next month.