Where a Small-Cap Value Investor Sees Quality in Tech—Royce
article 05-10-2022

Where a Small-Cap Value Investor Sees Quality in Tech

Portfolio Manager Joseph Hintz, CFA®, Assistant Portfolio Manager for Royce Total Return Fund, talks about his quality value approach and how it sometimes leads him to overlooked technology companies.


What first drew you to small-cap investing?

During business school, I was fortunate to have an internship where I worked on five completely different mutual fund strategies, which ran the gamut from small- to large-cap, and from value to GARP (Growth at a Reasonable Price) to momentum growth. This experience gave me the opportunity to see multiple investment processes, use different methods to analyze the markets, and solidify my affinity for small-cap value investing. There are so many things to love about this style, but I feel that it is a space where you can uncover interesting companies that are mostly ignored by other investors and sell-side research firms. The sheer size of the small-cap universe often leads it to be underfollowed by most investors, so it can take more work to put together your mosaic analysis of a firm’s business prospects and financial drivers. However, that extra work is always intellectually gratifying and can often be highly additive to the investment process.

Can you detail your approach to finding quality in small-cap value stocks?

In the Small-Cap Quality Value Strategy that we use to manage Royce Total Return Fund, there’s a robust framework that the team applies across all our companies to gain a deep understanding of what drives quality. While we start with signature elements of quality—such as the return profile, profitability, cash flow generation, and capital structure—we also want to understand the core reasons why these companies can generate these strong financial metrics. Much of our rigorous research process centers on areas such as industry structure, the attributes the customer values most, unique assets that a company might have that create a competitive advantage, or process and / or human capital advantages that the company may possess. I would characterize it as a treasure hunt. We start with a key fundamental attribute such as high returns on invested capital, and then we start digging through the history of the company to figure out what they have done strategically to enable their strong market position. Equally important to this process, of course, especially when it comes to building our conviction in an investment, is looking closely at the risk parameters to make sure that we have both a solid understanding of the potential risks and the ways that the company is addressing those risks. These can come in multiple forms, and we are particularly interested in learning as much as we can about the competitive dynamics within an industry and the potential for any significant shifts in the demand profile of the products or services as we attempt to effectively manage risk.

As a value investor focused on quality, what are you looking for among technology stocks?

I think of two broad buckets where I try to find attractive small-cap value opportunities within tech: legacy technology that the market has deemed irrelevant and companies that are tangentially tied to broader secular trends but don’t get the same level of attention that a pure-play more closely tied to that trend might receive. Growth investors looking at tech stocks are often trying to identify secular trends and then pick those ideas that look most likely to succeed as those trends play out. One difficulty with this approach is that all those companies tend to have rich valuations because they’re directly exposed to these secular trends. On the other hand, our two categories provide a valuable lens through which we examine the companies that fall outside of the typical growth investing sphere.

Can you give us some details on legacy technology?

Many companies that fall into this category are justifiably cheap as their products are usually becoming increasingly irrelevant in the fast-moving world of technology, However, we look for those that may have a durable advantage that the market is missing. That advantage may come in the form of an attribute within their software, hardware, customer relationships, etc. that is somehow irreplicable or more critical to future technology trends than appears to be the case on the surface.

What can you tell us about the secular growth category?

We are not willing to pay stretched valuations just to get access to secular growth trends, but we do like to see growth in our companies. So we often look for opportunities to gain exposure to secular trends via companies that are not as immediately associated with that trend as a more pure-play company. Some examples would be a software company that also has a services segment that pure software investors do not want to analyze, or it could be an electronic equipment manufacturer that sells equipment or components that are an integral part of the manufacturing process for, say, electric vehicles. But because these parts are several steps removed from the actual vehicle manufacturer, the connection is not as obvious, and other investors pass it by.

How does your analytic process work in these categories?

It’s important for us to do a deep dive on the technology itself, regardless of whether it is a legacy technology, where we want to validate our assumptions around the durability of demand, or tied to a secular growth trend, where we want to ensure a strong moat around the company’s ability to serve that growth. We spend time making sure we understand the technology itself; we speak with customers, users, and competitors to understand the pain points that products are trying to solve; and we research the life cycle of the industry that the company is participating in. Technology is always advancing at an ever-faster pace, and so we are ever mindful of the risk that the technologies we are focused on could become displaced. That’s why we feel it is so important to develop deep fundamental views on the technology itself.

Can you talk about a position that exemplifies your approach to tech that is also doing well so far this year?

One stock that has so far enjoyed a strong year is Hackett Group, which is an IT consultancy. Hackett is an interesting example of our approach to small-cap tech investing, as it has characteristics from both buckets that we discussed. The company has struggled previously from a perception of having outdated legacy technology because part of their consultancy business was focused largely on Oracle software that was becoming less relevant as customers moved toward software consumption outside their own internal data centers. Hackett spent years unwinding that business and refocusing on Oracle solutions that are tied to software consumption in the newer preferred models, a process that created a multi-year headwind to revenue growth. It is easy to dismiss it as a company with no growth potential after a cursory glance because the shift within their Oracle business masked the growing demand for their underlying business. The opportunity, then, lies in the fact that most investors dismiss the company after that initial glance. Furthermore, that headwind is now behind the company, and they are very well positioned to take advantage of the strong secular demand that accelerated during the pandemic from businesses looking to further digitize processes within their operations. This leads us to how Hackett fits into the second bucket of our IT approach. In addition to having a strong consulting presence with high demand players such as Oracle and SAP within the public cloud, Hackett has a unique set of benchmarking data that’s been built over decades. This data creates a significant barrier to entry for competitors and gives them a strong advantage in helping companies rethink business practices in light of post-pandemic digitization trends. The company also continues to look for new ways to better monetize and leverage their position with that benchmarking data asset, which provides even further avenues for future growth. While Hackett may not be the first company that comes to mind when thinking about secular growth coming from broad digitization strategies, we think they have a very defensible role to play in that trend. Equally important is the fact that its shares have recently sold at less than 15x next year’s earnings, which we think is a very attractive multiple for a company with a net cash balance sheet that can grow revenues in the 5-10% range and EPS (earnings per share) in the 15-25% range in a durable fashion. We view this as an incredibly attractive opportunity despite its impressive performance year to date.

Hackett Group (Nasdaq, HCKT) 12/31/21-5/5/22

$20.53 for 12/31/21 to $24.18 for 5/5/22

Past performance is no guarantee of future results

Can you discuss a high confidence holding that’s lagged so far in 2022?

While we often find interesting opportunities in areas that are less common for value investors, such as technology, we are also active in the traditional value segments like Industrials. For example, we like Simpson Manufacturing Co., which sells connectors, fasteners, and truss products predominantly into the residential construction market. We began to reinitiate a position during February and March of this year as its stock price was falling. We think of Simpson as a high-quality engineering company—which is led by a CEO who is an engineer—that happens to sell products into the residential construction market. And the total cost of their products is miniscule relative to the overall expense of a building project—yet at the same time they are critical for the structural integrity of the building. As an example, while demand for their products is tied to overall housing starts in the U.S., they are more closely tied to housing starts in areas that are more prone to natural disasters, which elevates the need for high quality structural integrity inputs. Simpson’s position within the market ultimately gives it very strong pricing power, which was aptly demonstrated in 2021 when the company instituted four price increases throughout the year that more than offset input cost inflation. These characteristics have helped the company generate extraordinary returns on capital throughout the economic cycle. However, the stock has been weak so far in 2022 for two main reasons: First, Simpson completed a sizeable acquisition recently that significantly expands their exposure to the European and commercial construction markets, and investors have been cautious about this strategic move. Second, and perhaps most important, the market is concerned about rising rates impacting demand for single-family homes as we move through the year. We’re aware of the risks that come with any sizeable acquisition but think that the company is appropriately focused on its integration. We are also excited about the scale that the deal brings to their European business. Further, while we acknowledge that rising rates will most certainly impact housing demand, the work we have done supports the view that there is both a structural under-supply of housing in the U.S. from years of lower build levels and a sustainable increase in demand resulting from demographic shifts. As such, we view this as an attractive opportunity to build weight in a high-quality company at 15x next year’s earnings, which we think is very attractive relative to the incredible returns on capital and growth rates that the company has generated through the years.

Simpson Manufacturing Co. (Nasdaq, SSD) 12/31/21-5/5/22

$139.07 for 12/31/21 to $105.89 for 5/5/22

Past performance is no guarantee of future results

Important Disclosure Information

Average Annual Total Returns as of 3/31/22 (%) 

Total Return -2.51 4.71 12.12 8.87 9.95 7.46 8.58 10.55 12/15/93
Russell 2000 Value -2.40 3.32 12.73 8.57 10.54 6.91 8.55 10.01 N/A
Russell 2000 -7.53 -5.79 11.74 9.74 11.04 7.99 8.72 9.12 N/A

Annual Operating Expenses: 1.25

1 Not annualized.

All performance information reflects past performance, is presented on a total return basis, reflects the reinvestment of distributions, and does not reflect the deduction of taxes that a shareholder would pay on fund distributions or the redemption of fund shares. Past performance is no guarantee of future results. Investment return and principal value of an investment will fluctuate, so that shares may be worth more or less than their original cost when redeemed. Shares redeemed within 30 days of purchase may be subject to a 1% redemption fee, payable to the Fund, which is not reflected in the performance shown above; if it were, performance would be lower. Current month-end performance may be higher or lower than performance quoted and may be obtained at www.royceinvest.com. Operating expenses reflect the Fund's total annual operating expenses for the Investment Class as of the Fund's most current prospectus and include management fees, other expenses, and acquired fund fees and expenses. Acquired fund fees and expenses reflect the estimated amount of the fees and expenses incurred indirectly by the Fund through its investments in mutual funds, hedge funds, private equity funds, and other investment companies.

Mr. Hintz’s thoughts and opinions concerning the stock market are solely their own and, of course, there can be no assurance with regard to future market movements. No assurance can be given that the past performance trends as outlined above will continue in the future.

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.

Percentage of Fund Holdings As of 3/31/2022 (%)

Total Return

Hackett Group


Simpson Manufacturing Co.


Company examples are for illustrative purposes only. This does not constitute a recommendation to buy or sell any stock. There can be no assurance that the securities mentioned in this piece will be included in any Fund’s portfolio in the future.

Sector weightings are determined using the Global Industry Classification Standard ("GICS"). GICS was developed by, and is the exclusive property of, Standard & Poor's Financial Services LLC ("S&P") and MSCI Inc. ("MSCI"). GICS is the trademark of S&P and MSCI. "Global Industry Classification Standard (GICS)" and "GICS Direct" are service marks of S&P and MSCI.

Return on Invested Capital is calculated by dividing a company’s past 12 months of operating income (earnings before interest and taxes) by its average invested capital (total equity, less cash and cash equivalents, plus total debt, minority interest, and preferred stock).

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. All indexes referenced are unmanaged and capitalization weighted. The Russell 2000 Index is an index of domestic small-cap stocks that measures the performance of the 2,000 smallest publicly traded U.S. companies in the Russell 3000 Index. The Russell 2000 Value and Growth indexes consist of the respective value and growth stocks within the Russell 2000 as determined by Russell Investments. The performance of an index does not represent exactly any particular investment, as you cannot invest directly in an index.

This material is not authorized for distribution unless preceded or accompanied by a current prospectus. Please read the prospectus carefully before investing or sending money. The Fund invests primarily in small-cap stocks, which may involve considerably more risk than investing in larger-cap stocks. (Please see "Primary Risks for Fund Investors" in the prospectus.) The Fund’s broadly diversified portfolio does not ensure a profit or guarantee against loss. The Fund may invest up to 25% of its net assets (measured at the time of investment) in securities of companies headquartered in foreign countries, which may involve political, economic, currency, and other risks not encountered in U.S. investments. (Please see "Investing Foreign Securities" in the prospectus.)



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