One of my favorite investors is Chuck Royce. He is one of the pioneers of small cap investing in the US over 35 years back. The Royce fund families have an excellent track record.
Here are some excerpts of the investment approach at Royce Funds taken from their website.
Bottom-up Stock Selection Approach
We employ a bottom-up approach to choosing portfolio holdings, one that focuses on individual stock selection. Our goal is primarily to identify promising companies that have the following characteristics:
- Strong balance sheets
- High internal rates of return
- Ability to generate free cash flow
Generally, we seek to purchase companies trading at discounts of at least 30% and preferably 50% to our estimate of their value as businesses. We will generally sell a position when the company reaches our estimate of its value.
- We are price-driven, not position-driven
- We generally set buy and sell targets for positions
- Cash is a byproduct of our investment process
Our methods concentrate on managing risk in three ways:
To reduce business risk, we generally look for companies that have strong balance sheets, high internal rates of return and excess cash flow. Our estimate of a company’s ability to withstand economic adversity is a significant measure of its financial good health. We want to know what the potential risk is of “permanent capital impairment,” i.e., the likelihood of a business not being able to generate sustainable returns on assets or, even worse, becoming insolvent.
We attempt to reduce valuation (or price) risk by buying stocks that are trading at what we believe are bargain prices. The price we pay for a company must be significantly lower than our estimate of its current worth.
We seek to reduce portfolio risk by owning a wide variety of stocks, across many sectors and industries.