Fortune 40: Small wonders
Our small-cap portfolio employs strategies used by Chuck Royce, founder of Royce Funds and a pioneer in small-cap investing. We based our screen on Royce's time-tested technique for identifying profitable and well-run small caps - those with market values of $250 million to $2.5 billion. We required at least 8% return on assets (net income divided by total assets) and positive free-cash flow (Royce did not comment on our screen). We also looked for low P/E and price-to-book ratios relative to the Russell 2000 index. And we considered only small caps with share prices below $35, as they are less likely to be covered by Wall Street analysts or heavily owned by institutions, giving regular investors a leg up. Our small-cap choices last year posted an enviable 28% gain.
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