Tom Gayner

Innovation In Small-Caps

Co-CIO Francis Gannon details opportunities for small-cap investors in sectors he believes may be overlooked.

Q1 hedge fund letters, conference, scoops etc


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Which sectors do you think investors are overlooking?

I think one of the more overlooked aspects of the investing world today is that innovation is the sole province of a large-cap growth company, specifically within technology. In our world we’ve seen it play out not only in technology, but within healthcare; specifically biotechnology companies. And people believe that that is the only place you can find innovation and therefore growth has, for all intents and purposes, outperformed; I think for a variety of reasons, but that being one of them.

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I take solace in the fact that there is massive amounts of innovation taking place in the United States within industrial businesses, in the heartland of our country, that I think people are overlooking. And it’s not just within industrial businesses, it’s also within boring technology companies. The non-sexy part of technology. The parts that are not involved in the internet.

How does the shortage in skilled labor play into this?

So I think what you’re finding in many manufacturing companies in the United States is they’re using more technology and innovation to actually take advantage of the fact that there is a lack of a skilled labor out there today. And what you’re finding is technology is helping these companies in terms of welding, automated welding, machine vision systems, lasers. All of which have become a normal part of the manufacturing world that the market, for all intents and purposes, has completely overlooked.

As we look for cool, new disrupting technologies in the large-cap growth world, you’re actually finding them, I think, a lot of unique disruptive technologies within the small-cap industrial electrical equipment machinery, boring technology type space as well.

How is this creating opportunities for small-cap investors?

So in a world where people are rushing just to own an index, or an ETF, I think the opportunity for an active manager within a small-cap space and for small-cap investors is to look at these great businesses that have been left behind, where there is an enormous amount of automation, an enormous amount of innovation, that is being reflected in what and how these companies operate on a daily basis.

The valuation, you know, compared to most growth companies that are considered innovative, in many of our businesses that we focus on, that I would say are involved in automation or innovation, actually are not only attractive from a valuation standpoint, but a shocker, they actually have cash flow and earnings, which you don’t seem to find in many of the larger-cap innovative businesses today.

Article by The Royce Funds

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