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By Jason Stipp | 01-25-2010 05:24 AM

Big Opportunity in Small-Cap Tech

Legg Mason ClearBridge managers Jeffrey Russell and Aram Green on small-cap valuations today and opportunity in tech.

Jason Stipp: I'm Jason Stipp with Morningstar. As small-cap stocks have led the way out of the downturn, we checked in with managers of Legg Mason ClearBridge Small-Cap fund to see where they're seeing opportunity today and what has attracted them to the tech sector.

Stipp: Given the recent rally of small-cap stocks, how do valuations look today?

Jeffrey Russell: You're correct that small-cap stocks have been some of the market leaders coming out of the bottom of the market in March of 2009. And that's very typical that small-cap stocks indeed are the leaders of the market in five out of the last economic recoveries that we have witnessed.

Small-cap stocks have very strong earnings growth, they are the job creators, and they are the highest innovators. And they're the beneficiaries of liquidity in the marketplace as demand for stocks start to improve.

Aram and I look very closely at valuation of the companies that we own in the small-cap growth portfolio. We're very valuation attuned, and it's hard to generalize about the overall valuation of the small-cap market because there's such diversity and breadth overall. So we are very honed in on the companies that we want to own and pay a fair price for the growth dynamics that we see.

Stipp: Where are you finding opportunities in technology?

Aram Green: Well, tech represents a very large weighting in our benchmark, the Russell Growth 2000. We have been generally equal weight or overweight that area, and predominantly our exposure is in software stocks. And the reason why we own a tremendous number of software stocks within the small-cap portfolio at ClearBridge is because we like the business model characteristics.

If you look at software stocks and the ones that are publicly traded that we own, they have a substantial amount of ownership by the management. And some of those are former founders of the company, so our interests are very much alike and aligned.

In addition to that, the business models lend themselves to a very recurring nature. A large percentage of the revenue that gets generated every quarter is under maintenance contracts or annual license contracts. So there's a great degree of stability in the revenue that they generate.

These businesses also have very high margins and generate a lot of cash. And we think that if you look at those businesses, these are companies that we can own over a multi-year time horizon that are going to grow rather significantly and generate lots of cash and today are trading at very attractive market values.


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