The Royce Funds' Jay Kaplan on Small-Caps, Value Investing, Dividends and more

Jay Kaplan’s Bio from Roycefunds.com

Jay S. Kaplan, CFA, is a Portfolio Manager and Principal for Royce & Associates, LLC, investment adviser to The Royce Funds.

He serves as Portfolio Manager for Royce Capital Fund—Small-Cap Portfolio, co-manages Royce Value Fund with Whitney George, and Royce Dividend Value Fund with Chuck Royce. He also serves as an Assistant Portfolio Manager of Royce Pennsylvania Mutual Fund and Royce Total Return Fund. He has 20 years of investment industry experience.

Prior to joining Royce & Associates in November 2000, Mr. Kaplan spent 12 years with Prudential Financial, most recently as Managing Director and Portfolio Manager of the Prudential Small Company Value Fund.

He holds a bachelor's degree from the State University of New York at Binghamton and earned a Master of Business Administration degree from New York University.

Value investing is contrary to human nature, how did you get started in value investing? Also on a similar note there are many different schools of value investing, which school would you say you adhere to the most? Who has had the greatest influence on your investment philosophy?

I am not really sure that it’s contrary to human nature. Everyone likes to buy stuff on sale and nobody likes to pay full price. From that perspective, value investing is not contrary to human nature at all. Buying a good asset at a discount is something that everyone can relate to.

I started out as a credit analyst. There are really two ways you can look at credit. You can look at assets or you can look at cash flow and how a company meets its financial obligations. So you’re looking at stress testing and the volatility of cash flows, and how bad things could be before a company can’t pay its bills.

Applying that to stocks, it’s like looking at a margin of safety. It is about how bad things can get before you lose money. My core philosophy is that if I buy stocks where expectations are low to non-existent, and those expectations are met, I probably won’t lose money. And if those expectations are exceeded, there could be a nice upside.

I also adhere to Royce’s core principles, which consist of finding companies with pristine balance sheets, high returns on capital and buying them at attractive prices. However, my core approach comes from my experience as a credit analyst and buying stocks based on cash flows.
我也坚持Royce的核心原则，包括寻找干净的资产负债表，高的资本回报并在有吸引力的价格购买。但是我的核心方法源于我的信贷分析员的经历，购买股票基本都基于现金流。

 

I was also a junk bond analyst for a few years, which gave me a good fundamental underpinning for my current value approach. My core focus on credit and cash flows have had the largest impact on me.
我也作过几年的垃圾债分析师，这为我现在的价值方法打下了好的基础。但信贷和现金流对我的影响最大。

What does a typical day look like?

There really is no typical day. There is a typical start of the day, which consists of waking up early and commuting. We check positions and prices and more often than not the news dictates what the rest of the day will be. If the day does not contain much news, we will focus on looking into new holdings. If the day is full of news, then it could be a day of maintenance.
我们检查仓位和价格，时常新闻会指示我们一天中的其它时间是什么样子。如果这一天没有很多新闻，我们集中精力做一些新持仓的研究。如果整天都是消息，那这一天就是维护旧品种的一天。

During the course of the day, there are usually meetings with management teams, often several of them. There are client meetings, though we have less here than at other firms. We spend more time managing money.

So the early part of each day is pretty similar, but the second part of the day you never know. That is one thing that makes the job so fascinating. You don’t know what each day will bring.
所以一天中前面的时间都差不多，后面的事情你永远无法预料。这也是这个工作如此令人着迷的一部分。你不知道每天都会发生什么。

Several of your funds are run with other portfolio managers; do you all have to reach a unanimous decision before buying or selling a stock?

We don’t always reach unanimous decisions. Some Funds are set up differently. We tend to take larger positions in companies in which there is widespread agreement and smaller positions when there is less of a consensus.

You co-manage several funds with Charles Royce, are you ever able to convince your boss of your convictions when he does not agree with you initially? There are times where he’ll ask me, “Why are you buying or selling XYX Company?” and I will tell him why, and then he will go and make his own decision. In many organizations, the object of the game is to convince someone senior to you to do what you want. That is not how we operate. When Chuck sees something, he will ask about it, not to tell me not to do it, but rather to see if I want to do to it. I will tell him what I think and then he will do what he thinks. Sometimes he agrees, and sometimes he doesn’t agree. Everyone is entitled to his opinion here. Since all Royce Funds are diversified how are you able to keep track of so many securities? As a firm, we are very focused on the small-cap market. So we know a lot about lots of small-cap securities. The managers here also tend to be very experienced. We usually don't hire people right out of college on our investment staff. Most of the people come with significant experience and know a lot of companies. So when you have been doing it long enough, you are able to keep track of a lot of companies.

Most companies’ fundamentals don’t change very much. When companies do change materially, that is what you focus on. It is the 80/20 rule; you spend 80% of your time on 20% of the names because a lot of things do not change much in a short amount of time.

How do you manage risk?

First, let me tell you how we define risk. A lot of people define risk as the amount your portfolio deviates from an index. We do not think of risk in that way. We think about risk as not losing money. We hate losing money.

So we like to think about our performance in terms of risk adjusted terms relative to an index. With that in mind, we run diversified portfolios because there is a lot more risk in small-cap companies. Another core component of our philosophy is that we invest in companies that have very strong balance sheets, which we think provides good protection against the company going to zero.
我们认为风险是不赔钱，而不是仓位与指数的偏离。怀着如此心态，我们的组合比较分散，因为小盘股有更多的风险。我们投资哲学的另一个核心部分是我们投资具有健康资产负债表的公司，我们认为这可以很好地保护我们避免公司变得一文不值。

You know, when you’re a value investor you invariably run into problems, whether it’s an industry problem, a company-specific problem or something else. When we see companies at what we think is a good price, the company usually has problems. So between diversification and buying companies with strong balance sheets, we try to manage risk.
你知道，作为价值投资者你不可避免会遇到问题，可能是行业问题，一家公司特有的问题或者其它什么。当我们看到我们认为便宜的公司时，这个公司通常都会有些问题。所以在多样化和购买健康资产负债表之间，我们在试图管理风险。

Do you ever meet with management?

All the time. With small companies, we meet with the most senior people and discuss strategy and any issues in the company. We like continuity of message and we want people who do what they said they were going to do. This is very important to us. If they tell us they are going to do xyz, and we meet with them six months later and they have not done xyz, that makes us uncomfortable.

How do you go about finding stocks? Do you look at the 52 week low list? Do you use a screener for stocks with high dividends and low payout ratios?
你如何寻找股票？你看52周新低排名吗？你使用高红利和低支出比率来选股票吗？

I do not look at 52-week lows, or high dividends or low payout ratios. I screen based on balance sheets, return on capital and valuation. In valuation, we look at operating income instead of P/Es.
我不看52周新低，或者高红利或者低支出。我基于资产负债表、资产回报和估值进行筛选。在估值中，我们看营业利润而不是P/E。

We also meet with companies, as I mentioned earlier, and we watch news flows. Most small-caps are relatively less liquid, but when there is news they tend to become very liquid for a short period of time. Because of our knowledge of companies, we are good at acting on news. But at the end of the day, it comes back to those three principles: balance sheets, return on capital and valuation.
许多小盘股流动性相对较差，但一旦有什么消息时流动性在短期内就会变得很好。因为我们对公司比较了解，我们对依靠新闻而采取行动比较内行。但一天结束的时候，它又会转回三个原则：资产负债表、资产回报和估值。

One argument for buying stocks with dividends is that a dividend will cushion a stock’s fall as bargain hunters see an attractive yield and start buying the stocks. After the peak of the financial crisis where many companies dramatically lowered or eliminated their dividends do you think this argument still holds weight? Or do you see the events of the past few years as an anomaly unlikely to repeat itself anytime in the near future?

As we saw in late 2008 and early 2009, it's tough for any stock to be fully cushioned in a financial crisis. However, most companies that we owned are now back in good financial shape and didn't experience dramatic dividend declines.

In our funds that have a dividend-paying component, we don’t chase high dividends. We think about dividends as part of the menu of items in a company’s capital allocation toolkit. There are a few things a company can do with its free cash flow: they can reinvest it in the company, they can do mergers and acquisitions, they can pay down debt if they have it, they can buy back stock, or they can pay dividends.

So when we look at dividends, we frame it in the context of what is the best risk-adjusted use of capital for the company—could giving some of the money back be part of that? If you do not have a good way to use that money, maybe you should give it back.

When companies decide to pay a dividend, we see that as a commitment on their part. Companies almost never want to cut or eliminate dividends. I see dividends as more like a marriage than a date. It is easier to break up when you are dating than after you’re married. So when a company decides to pay a dividend, it is using one of its capital allocation tools.<

If we just chased the highest dividends, it would probably lead us to companies under stress where the market doesn’t believe those dividends are sustainable, which would set us up for those dividends to be cut. Or it leads you into Master Limited Partnerships, REIT's or Utilities, which are areas we tend to avoid, because, those companies often don’t meet our balance sheet and return on capital criteria. So we don’t hunt for the highest paying dividends we can find.

I think dividends are good capital allocation tools, and are a sign of good discipline. This tends to lead me to more mature companies. Most of our dividend-paying stocks tend to be even more conservatively managed than many of our other stocks because the companies tend to be more mature.

With interest rates at record low levels do you think stocks that pay dividends are even more important?

No, but it is nice to get a better yield. But I am not sure it is a factor for us. We are really trying to find good investments—and if it has a dividend that is a plus. If you look at the small-cap universe (and it’s also true for large-cap companies) during the rally that began in March 2009, stocks that don’t pay dividends have significantly outperformed stocks that do. In general, we think companies that pay dividends are higher quality, and the rally has so far been led by low-quality stocks. Hopefully in the next phase of the bull market (whenever that is), higher quality, dividend-paying stocks will outperform.

I have seen studies that show that on an after tax basis dividend stocks barely outperform non-dividend stocks? Do you believe these studies are flawed? If not, do you think dividend stocks are best to hold in a tax-free account?

I have not seen the studies, so I can’t comment on it. All things being equal, it may be better to hold taxable income-producing securities in a tax-free account.


Large cap stocks are usually more able to withstand economic downturns without eliminating or decreasing their dividends. How do you ensure when you buy small-cap stocks that the company can keep paying the dividends and increasing them in the future?

We can never be sure. There are no guarantees, and there’s always risk. For us, it always goes back to good balance sheets, good free cash flow generation, and high returns on capital. We think these things give us a margin of safety. These things also mean the company has a good chance of being able to keep paying the dividend.

We understand that when times get tough, it sometimes makes sense to cut the dividend. For us, it is all about capital allocation management. And if you think about it, when people give us money to manage they are giving us capital to allocate. When we invest that money in stocks, we are entrusting the companies to allocate that money well. The whole dividend question is really about efficient capital allocation.

Small-caps have outperformed large-caps this past decade. Do you believe there will be a reversion to the mean, and large-caps will outperform small-caps in this next decade?
小盘股在过去十年都战胜了大盘股。你认为会有均值回归现象吗？在下一个十年大盘股会战胜小盘股？

I can’t predict what will happen over the next ten years. But if history is any indication, small-caps have outperformed over very long periods of time and there is no reason to expect that to change. There are cycles, of course. Small-caps have had a pretty good run. But when you come out of recessions, small-caps tend to do very well, so maybe this is not out of the ordinary.
但如果历史可以作出指示的话，小盘股在非常长的时期里都胜出了，而且没有理由去期望这种状况会改变。当然，有周期的原因。小盘股在过去经营得非常好。但当你走出衰退，小盘股的趋势是非常好的，所以这也没什么特别的。

If I knew what the future would be, I could just retire. Everyone in this business tries to prognosticate—half will be right and half will be wrong. We come in every day and look at our portfolio and look at the market and try to get a good risk-reward return, and we hope to deliver long-term satisfactory results. Sometimes large-cap does better and sometimes small-cap does better. Right now, small-caps are outperforming. Will that continue? I am not sure.
如果我知道未来会怎样，我就可以退休了。这个行业中的人人都试图预测——对错也是对半。。。。有时大盘股表现好，有时小盘股表现好。现在，小盘股胜出了。还会不会继续？我无法确定。

My investment ideas have been inspired by many of value investors including Benjamin Graham, Charles Royce, John Neff, Joel Greenblatt, Peter Lynch, Seth Klarman,Martin Whitman and Bruce Greenwald. .I live with my wife and daughter in Monsey, NY. I can be contacted jacobwolinsky(AT)gmail.com and my blog is www.valuewalk.com