High Valuations + Ample Leverage = Risky Russell? | Royce
article , video 02-07-2018

High Valuations + Ample Leverage = Risky Russell?

Co-CIO Francis Gannon on why too many companies with high leverage and/or no earnings make the Russell 2000 Index look risky.


Does the Russell 2000 look risky to you?

I think one of the things investors are missing in looking at the overall market is how risky the Russell 2000 is, going into 2018. I focus on really three aspects of it. One is obviously valuation. We know the Russell 2000 is expensive, by any stretch of the imagination. In fact, if you actually include the nonearning portion of the Russell 2000, which is rarely included when people read about it in the paper, it's even more expensive than it really looks, at the moment. The other thing is I think people are not focusing on the leverage in the Russell 2000. We've seen increased leverage from a financial standpoint within the Russell 2000.

Higher Leverage
Russell 2000 Average LT Debt to Capital1


1LT Debt to Capital is calculated by dividing a company's long-term debt by its total capital

In fact, the debt-to-capital ratio at the end 2017 was actually higher than where it was at the end of 2007. People aren't focusing on financial leverage within many of these businesses right now. And last but not least, I think we live in an environment where the Russell 2000 has had a high portion of the index be non-earning companies. 

Risky Russell?
Russell 2000 % of Non-Earning Companies


So at the end of 2017 slightly over 34% of the Russell 2000 was comprised of non-earning companies. People are thinking that many small-cap companies will benefit from the recently passed tax package. But 34% of the Russell 2000 is comprised of lossmaking companies that truly won't benefit, from many of the things that have taken place from, a tax standpoint. So I think the Russell 2000 as an index is increasingly more risky than people have really thought about, and it's a period of time where people have to be increasingly selective in terms of how they approach the small-cap asset class. 

Important Disclosure Information

The thoughts and opinions expressed in the video are solely those of the persons speaking as of January 9, 2018 and may differ from those of other Royce investment professionals, or the firm as a whole. There can be no assurance with regard to future market movements.

The performance data and trends outlined in this presentation are presented for illustrative purposes only. Past performance is no guarantee of future results. Historical market trends are not necessarily indicative of future market movements.

Frank Russell Company (“Russell”) is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell® is a trademark of Frank Russell Company. Neither Russell nor its licensors accept any liability for any errors or omissions in the Russell Indexes and / or Russell ratings or underlying data and no party may rely on any Russell Indexes and / or Russell ratings and / or underlying data contained in this communication. No further distribution of Russell Data is permitted without Russell’s express written consent. Russell does not promote, sponsor or endorse the content of this communication. The Russell 2000 Index is an unmanaged, capitalization-weighted index of domestic small-cap stocks. It measures the performance of the 2,000 smallest publicly traded U.S. companies in the Russell 3000 Index. The performance of an index does not represent exactly any particular investment, as you cannot invest directly in an index.

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