Chuck Royce’s Top Stock Picks

Meena is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

We maintain a database of quarterly 13F filings from hundreds of hedge funds and other notable investors, which we use to develop investment strategies; for example, we have found that the most popular small cap stocks among hedge funds outperform the S&P 500 by an average of 18 percentage points per year.

Individual funds’ filings can also be tracked over time, and while we don’t recommend blindly imitating their picks (among other reasons, the information in 13Fs can be outdated by the time these filings occur), we think they can serve similarly to a stock screen in that investors can consider individual names and decide if they are worth a closer look.

Read on for our thoughts on the five largest holdings from Chuck Royce’s mutual fund Royce & Associates as of the end of March or see the full list of the fund's stock picks.

Industrial stocks

Reliance Steel & Aluminum (NYSE: RS) was the largest holding in the portfolio, at a little less than 6 million shares. Contrary to the performance of many other industrial metals companies, Reliance is actually up about 40% over the last year. However, the first quarter of 2013 was not very good with revenue and earnings both declining at double-digit rates versus a year earlier.

The stock trades at 14 times trailing earnings, which would be an attractive valuation if business was improving but given the actual results, it doesn’t look like a good buy right now.

Royce trimmed its stake in Lincoln Electric Holdings (NASDAQ: LECO), but still had 7.6 million shares in its portfolio at the beginning of April. Lincoln Electric manufactures and sells welding and cutting products. Its financial reports show essentially flat performance compared to a year ago, but the markets are apparently quite optimistic about the stock: the $5.2 billion market cap represents a trailing P/E multiple of 20.

Billionaire Ken Fisher’s Fisher Asset Management owned 1.1 million shares of Lincoln Electric according to its own 13F (find Fisher's favorite stocks).

Three more of Royce’s top picks

The fund increased the size of its position in Nu Skin Enterprises (NYSE: NUS), which distributes personal care and nutritional products, to a total of 8.3 million shares. It is a multilevel marketing company, so we’d be a bit concerned about regulation and about the sustainability of growth, but for what it’s worth, revenue grew 19% in its last quarterly report compared to the first quarter of 2012, with net income up 14%. Markets have priced in some future growth -- the trailing P/E is 21-- but analyst forecasts imply a five-year PEG ratio of 0.8.

Royce and his team reported owning 7.5 million shares of $2.6 billion market cap apparel retailer Buckle (NYSE: BKE). Buckle is a popular short target, with 26% of its float held short. The valuation doesn’t seem to be particularly high -- the trailing and forward earnings multiples are 16 and 15, respectively -- but at that pricing, there would have to be at least some earnings growth in order to make it a good value.

There’s been little change in the company’s financials relative to the levels a year ago, however, and so, there may be better buys among apparel retailers.

Rounding out our list of Royce’s top five picks is Federated Investors (NYSE: FII). The $3 billion market cap asset management company is valued at 16 times earnings, whether we consider its trailing results or consensus forecasts for 2014. This suggests that analysts consider the company’s growth prospects to be limited, and in fact, sales and net income each changed less than 2% in its most recent quarter compared to the same period in the previous year. Federated Investors is another popular short target; short sellers are responsible for 18% of the float.

Conclusion

We don’t see why shorts are so excited about Federated Investors or Buckle, but we wouldn’t be either, given their stagnant performance. The same goes for Lincoln and Reliance, where recent results have been too weak for us to consider them as potential value plays.

Nu Skin certainly has a number of risks related to its business model, and so, we would certainly hesitate there as well, but it has been growing its earnings and if it could continue to do so for the next several years and hit analyst targets, it could certainly justify the current valuation.

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This article is written by Matt Doiron and edited by Meena Krishnamsetty. They don't own shares in any of the stocks mentioned in this article. The Motley Fool recommends Federated Investors and The Buckle. The Motley Fool owns shares of The Buckle. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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