In the recently published quarterly report from Royce Funds, the leading microcap manager makes a strong case for why microcap stocks could be entering a period of outperformance.
Many investors are familiar with studies that show how small-caps have been the top-performing asset class as a long-term investment over the past century. But few are aware that this performance has been largely driven by the microcap segment of the smaller-company universe.
In its report, Royce used performance data from the Center for Research in Security Prices, which tracked data back to 1925. From this point to the end of May 2012, the average annual returns for the microcap segment were 12.0%, compared to 11.3% for the broader small-cap group and only 9.3% for large caps.
Drilling down further into this data, Royce examined the monthly rolling average annual 10-year returns of the microcap segment. Their insight from this vantage point showed a consistent reversion to the mean; periods of high returns were followed by periods of low returns, and lower-return periods were followed by periods of outperformance.
So what does this mean for today’s microcap investor?
We just need to look at the relative valuation of the Russell Microcap Index compared to the Russell 2000 to see that microcaps are trading at solid discounts on both a weighted average P/E and P/B basis. Additionally, while the Russell 2000 reached a new high in April 2011, the Russell Microcap Index is still trading below its July 2007 peak.
Together these facts point to a period of solid outperformance dead-ahead for microcaps. Some stocks worth looking into include workplace and workforce solution provider Asure Software (NASDAQ: ASUR), mobile app developer MEDL Mobile Holdings (OTCBB: MEDL), and PRC-based fuel distributor Longwei Petroleum (NYSE MKT: LPH). Each of these microcaps offers compelling near-term catalysts that could send their shares higher. Combine these catalysts with a solid market tailwind and you get a great profit opportunity.
Disclosure: The subject securities are clients of RedChip Companies, Inc. RedChip Companies, Inc., employees and affiliates may have positions and affect transactions in the securities or options of the issuers mentioned herein. For full financial disclosures for all RedChip clients, please visit http://www.redchip.com/disclosures.asp?src=rcv.