Steven Scruggs, manager of FPA Queens Road Small Cap Value mutual fund, says now is a good time for small-capitalization and for value.
Small-cap stocks have attractive valuations compared to large-cap, and value stocks are attractive compared with growth, he says. He has a three- to five-year time horizon for his holdings.
Scruggs’ investment philosophy has fared well, with the FPA Queens Road fund sporting a five-year annualized total return of 8.4% through Jan. 27. That compares with 5.03% for the Russell 2000 Value index, the benchmark for his fund.
Here are Scruggs’s thoughts, including two stock picks.
Street.com: What’s your investment philosophy?
Scruggs: We use classic Ben Graham principles, focusing on fundamentals. We’re bottom-up investors with a long-term view: three to five years.
Our four investment pillars are balance-sheet strength, valuation, management quality and expectations for a company’s industry. In terms of management, the culture of a business can’t be overestimated, though it’s not quantifiable.
We do well in down markets. We trail a bit in up markets. But for full cycles we tend to outperform.
Street.com: What’s your outlook for small-cap versus large-cap stocks this year?
Scruggs: At current levels, small-cap stocks have been cheaper relative to large-cap only four times in the last 30 years. We’re not buying the broad market, but there are more attractive opportunities in small-cap versus large-cap.
Courtesy of FPA
Street.com: What’s your outlook for value versus growth?
Scruggs: Before getting hit hard last year, growth outperformed over the last decade. But that’s an outlier. It was a result of easy money policy. But that has started to turn. Even after last year, value-stock valuations look much better than growth.
Street.com: How much of someone’s stock portfolio might they devote to small-cap?
Scruggs: Of course that varies according to your time horizon, your circumstances and how much volatility you can take. Someone in their early 20s, with a 20- to 30-year time horizon, could have a third or half of their portfolio in small-caps. Someone approaching retirement wouldn’t want that much.
Our risk metrics are lower than the S&P 500. Small-cap stocks historically have higher returns than large-caps. Of course that wasn’t the case for the last decade, and we can’t say with certainty that things will revert to the mean.
But from the standpoints of diversification and historical returns, folks should take a look at small-caps and decide what their comfort level is.
Street.com: Do you think investors should have a mix of active and passive funds?
Scruggs: Our benchmark index is the Russell 2000 Value. Some of the index holdings clearly aren’t good investments. If you buy a basket of companies, you’ll probably get some you’d never invest in. We’re active and have proven we can outperform the benchmark.
Street.com: What are two of your favorite stocks?
Scruggs: 1. IAC (IAC), the Barry Diller company. It’s got a lot of moving parts. It has significant stakes in two public companies: MGM Resorts, (MGM) the casino company, and Angi [formerly Angie’s List]. (ANGI)
It also owns Dotdash Meredith, which is among the top 10 Internet media properties for traffic. You’re getting good value for Dotdash Meredith.
Diller starts companies within companies and has had great success -- Match, Trip Advisor, Live Nation. He’s doing that now with Toro, an Uber of rental cars. About 2.5 million people used it last year. Diller grows the businesses and then spins them out.
2. ServisFirst Bancshares (SFBS), a community bank based in Alabama. It’s primarily a commercial bank and is very digitized. It’s very efficient, so it can offer higher interest rates to depositors and spend more money on services.
It sticks to small- and middle-market companies and stays out of bigger markets. They are conservative lenders. They know their niche and dominate it. One of the founders remains the CEO. That keeps the philosophy in place.
