Unwinding a Broken Clock

Signs that value is coming back into favor have many frugal investors feeling giddy.

We share that enthusiasm but don’t anticipate that a return to a normal market will take place overnight.

Through the end of May, the Russell 2000® Value Index year-to-date is outperforming its growth counterpart by 630 basis points (bps). However, looking solely at Index returns doesn’t tell the whole story.

A closer review of the data shows that after nearly a decade of depressed interest rates and slow growth, investors have embraced companies using debt to generate sales.

Analysis of the balance sheets of the top 20 contributors in the Russell 2000® Value Index quarter-to-date, as shown, highlight this point. The median debt to estimated 2016 earnings before interest, taxes, depreciation, and amortization (debt-to-EBITDA) ratio for the group is 5.75x, meaning many of these companies are highly levered. By comparison, the names we own in our two small-cap strategies have a median debt to estimated 2016 EBITDA ratio of approximately 1.68x. We typically favor low-debt companies and believe they hold a particular advantage in periods of economic uncertainty.

While we welcome the outperformance by the Index, we believe the rally into highly levered names will prove to be a precursor to a rise of financially sound businesses trading at attractive valuations.


Past performance does not guarantee future results.

The statements and opinions expressed in this article are those of the presenter(s). Any discussion of investments and investment strategies represents the presenter’s views as of the date created and are subject to change without notice. The opinions expressed are for general information only and are not intended to provide specific advice or recommendations for any individual. Any forecasts may not prove to be true. Economic predictions are based on estimates and are subject to change.

Investing involves risk, including the potential loss of principal. There is no guarantee that a particular investment strategy will be successful. Value investments are subject to the risk their intrinsic value may not be recognized by the broad market.

The Small Cap Value Strategy seeks long-term capital appreciation by investing in small- and micro-cap companies, generally with market capitalizations of less than $2.5 billion at the time of purchase. The small- and micro-cap segment of the stock market is robust with thousands of publicly traded issues, many of which lack traditional Wall Street research coverage. Thus, we believe this market is often inefficient, mispricing businesses and offering opportunities for fundamental research-minded investors such as Heartland.

The Small Cap Value Plus Strategy primarily invests in companies that have a market capitalization between $250 million and $4 billion, with a majority of its assets invested in companies that pay dividends. The Strategy intends to capture the long-term appreciation of small-caps, while minimizing the volatility of returns inherent in the small-cap market. There is no assurance that dividend paying stocks will mitigate volatility.

Growth and value investing each have unique risks and potential for rewards and may not be suitable for all investors. A growth investing strategy typically carries a higher risk of loss and potential reward than a value investing strategy. A growth investing strategy emphasizes capital appreciation; a value investing strategy emphasizes investments in companies believed to be undervalued.

Heartland Advisors defines market cap ranges by the following indices: micro-cap by the Russell MicroCap®, small-cap by the Russell 2000®, mid-cap by the Russell MidCap®, large-cap by the Russell Top 200®.

Copyright 2016 FactSet Research Systems, Inc., FactSet Fundamentals. All rights reserved.

Definitions: Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA): measures a company’s financial performance. It is used to analyze and compare profitability between companies and industries because it eliminates the effects of financing and accounting decisions. Enterprise Value (EV): is the entire economic value of a company. Russell 2000® Value Index: measures the performance of those Russell 2000® companies with lower price-to-book ratios and lower forecasted growth characteristics. Russell Investment Group is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell® is a trademark of the Frank Russell Investment Group. All indices are unmanaged. It is not possible to invest directly in an index.

CFA is a trademark owned by the CFA Institute.

©2016 Heartland Advisors heartlandadvisors.com


© Heartland Advisors

Read more commentaries by Heartland Advisors