10 Stock Picks From Small-Cap Specialist Royce Funds

BOSTON ( TheStreet) -- Look at most mutual funds these days and you tend to see the same names in the top holdings, whether they fit in a fund's benchmark or not.

For example, iPad and iPhone maker Apple ( AAPL) is owned by almost 4,850 funds, including eight "small-cap" funds.

And with the S&P 500's gain of 11.3% this year, who wants to be left off that gravy train?

But it's clear that the large-cap benchmark is being driven mostly by Apple, which with its 50% gain this year and current $614 share price, makes up 4.6% of the index.

So as goes Apple, so goes the S&P 500, which should give many investors pause. "Some investors are angered by the 500's vulnerability to a Newtonian event: Apple falling to the ground, and the outsized impact that a declining stock price would have on the index," said Sam Stovall, S&P Capital IQ's chief equity strategist, in a market commentary.

But there's a whole other world of investing out there in small- and mid-cap stocks where investors can outdo many of the big guys while adding diversity to their portfolios.

The S&P Mid-Cap 400 Index is up 12% this year, while the small-cap bellwether Russell 2000 Index is up 9.8%. And, over the past three years, both indices have outperformed the S&P 500 by an average of 1 percentage point per year.

If you're shopping for small- and mid-cap stocks to diversify your portfolio, you'd be wise to start by looking at the portfolio of the small-cap stock fund specialist Royce Funds. Its motto is: "Small company investing is our core business."

Royce Funds, a family of 25 funds with $35 billion in assets under management, has an admirable track record. Its funds gained an average 11.9% in the first quarter and have a three-year average annual return of 27%.

Russel Kinnel, who writes the Fund Spy column for fund tracker Morningstar, noted recently that "71% of Royce's funds are rated 4 stars by Morningstar (out of a possible five). Now that's consistent!" Not to mention pretty good.

Its $3 billion small-cap blend fund, Royce Special Equity Fund ( RYSEX), gets a Morningstar "gold" rating, its highest, for its steady outperformance over its peers. The fund is up 9.2% this year and boasts a 10-year average annual return of 8.4%.

And in the mid-cap growth fund sector, its $7 billion Royce Premier Fund ( RYPRX) also earned a gold from Morningstar. It's up 9.4% this year and over 10 years it has returned an average of 10.5% annually.

So Royce's stock picks are worth a look for potential small- and mid-cap stock investors as its analysts do a lot of research to come up with its portfolio of relative unknowns.

The largest holding, firm-wide, at just over 1% of its assets, is Nu-Skin Enterprises ( NUS ), which makes and distributes personal care products and nutritional supplements, selling them directly or through a highly developed multi-level marketing network.

In 2011, it had sales of $1.7 billion and earnings of $2.38 per share, continuing a more than six-year trend of steadily rising revenue and earnings. And its shares carry a 1.39% dividend.

Another top Royce pick, Westlake Chemical ( WLK) has gained 35% this year. It's in a rather obtuse part of the chemicals industry as a producer of ethylene, polyethylene, and styrene chemicals, caustic soda and vinyls used to make fabricated PVC products, such as pipes. Goldman Sachs ( GS) added the company to its "conviction buy" list at the end of February.

Here are 10 Royce fund family stock picks in inverse order of their company-wide portfolio weighting:

10. Federated Investors ( FII)

Company profile: Federated, with a market value of $2.3 billion, is a provider of asset management services for institutional and individual investors.

Investor takeaway: Its shares are up 41% this year and have a three-year, average annual return of 1.7%. Its shares carry a 4.66% dividend yield.

Analysts give its shares seven "hold," ratings, one "weak hold," and one "sell," according to a survey of analysts by S&P. For fiscal 2012, analysts estimate it will earn $1.61 per share and that that will grow by 11% to $1.78 next year.

The company is a big manager of money market funds, with slightly more than $285 billion in such assets at the end of 2011, and as a result, historically low interest rates have made it difficult for Federated to maintain positive yields on these funds. Hence, investors have moved on to higher-yielding assets elsewhere.

9. Alleghany ( Y)

Company profile: Alleghany, with a market value of $6 billion, is an investment holding company that uses a value-oriented philosophy to acquire interests in attractive businesses and equity holdings principally in the insurance industry. The firm purchases fractional and outright stakes and generally holds them for long periods.

Investor takeaway: Its shares are up 19% this year and have a three-year, average annual return of 12%. Its shares get one "hold," rating from analysts, according to a survey of analysts by S&P.

8. Kennametal ( KMT)

Company profile: Kennametal, with a market value of $3.6 billion, produces metal-cutting tools and tooling systems used in the heavy equipment, aerospace, and automotive industries.

Investor takeaway: Its shares are up 23% this year and have a three-year, average annual return of 30%. Its shares have a projected 1.28% dividend yield. Analysts give its shares six "buy" ratings, three "buy/holds," five "holds," and one "weak hold," according to a survey of analysts by S&P.

7. Unit Corp. ( UNT)

Company profile: Unit, with a market value of $2 billion, is engaged in the contract drilling of oil and natural-gas wells in the Western U.S. It also owns about 75 producing wells.

Investor takeaway: Its shares are down 12% this year and have a three-year, average annual return of 12%. Analysts give its shares five "buy" ratings, one "buy/hold," and two "holds," according to a survey of analysts by S&P. Analysts expect it will earn $4.55 per share this year and that that will grow by 3% to $4.68 next year.

6. Buckle ( BKE)

Company profile: Buckle, with a market value of $2 billion, is a retailer of medium and higher-priced casual apparel for men and women. It operates more than 340 retail stores in 40 states.

Investor takeaway: Its shares are up 12% this year and have a three-year, average annual return of 16%. Its shares have a 1.77% projected dividend yield. Analysts give its shares one "buy" rating and nine "holds," according to a survey of analysts by S&P. Analysts estimate it will earn $3.43 per share in its current fiscal year and that will grow by 7% to $3.66 per share the following year.

5. Reliance Steel & Aluminum ( RS)

Company profile: Reliance, with a market value of $4 billion, is the largest metal service center in the U.S., providing metal processing services for carbon and stainless steel, aluminum, and alloys.

Investor takeaway: Its shares are up 16% this year and have a three-year, average annual return of 16%. The dividend rate is 1%. Analysts give its shares four "buy" ratings, five "buy/holds," two "holds," and one "weak hold," according to a survey of analysts by S&P. Analysts estimate it will earn $5.43 per share in 2012, and $6.27 in 2013, a 15% increase. S&P, which has it rated "strong buy," has a $70 price target on its shares, which is a 25% premium to the current price.

4. Westlake Chemical ( WLK)

Company profile: Westlake, with a market value of $4 billion, is an integrated manufacturer of petrochemicals, polymers, and fabricated vinyl products.

Investor takeaway: Its shares are up 53% this year and have a three-year, average annual return of 51%. Analysts give its shares two "buy/hold," ratings, four "holds," one "weak hold," and one "hold," according to a survey of analysts by S&P. The dividend yield is 0.4%.

S&P, which has it rated "buy," says natural gas-based ethylene producers such as Westlake "will benefit from a feedstock cost advantage over oil-based producers. The company also plans to expand its ethylene capacity in order to capitalize on new U.S. natural gas supplies."

3. Teradyne ( TER)

Company profile: Teradyne, with a market value of $3 billion, is one of the largest manufacturers of automated test equipment for the semiconductor industry. It also supplies systems to analyze the performance of circuit boards and integrated circuits.

Investor takeaway: Its shares are up 23% this year and have a three-year, average annual return of 46%. Analysts give its shares five "buy" ratings, four "buy/holds," and six "holds," according to a survey of analysts by S&P. For fiscal year 2012, analysts estimate that it will earn $1.53 per share and that will grow by 10% to $1.69 in 2013.

2. Lincoln Electric Holdings ( LECO)

Company profile: Lincoln Electric, with a market value of $3.8 billion, makes and sells welding and cutting equipment such as welding power sources, wire feeding systems, robotic welding packages, fume extraction equipment, and torches.

Investor takeaway: Its shares are up 19% this year and have a three-year, average annual return of 35%. Its shares have a 1.47% dividend yield. Analysts give its shares three "buy" ratings, one "buy/hold," and three "holds," according to a survey of analysts by S&P.

Analysts expect it to earn $3.06 per share in 2012, and that that will grow by 15% to $3.51 in 2013. The company has little long-term debt and $361 million in cash on the books.

1. Nu Skin Enterprises ( NUS)

Company profile: Nu Skin, with a market value of $3.6 billion, develops and sells personal-care products, nutritional supplements, and technology-related products and services directly to consumers through its sales force of more than 755,000 independent distributor. In a big break, Nu Skin recently received approval to begin directly selling its products in Beijing and around Shanghai in China, which may let it tap that nation's growing middle-class and its health and beauty needs.

Investor takeaway: Its shares are up 19% this year and have a three-year, average annual return of 64%. The stock carries a 1.39% dividend. Analysts give its shares seven "buy" ratings and one "buy/hold," according to a survey of analysts by S&P. Analysts estimate it will earn $2.97 per share in 2012, rising by 13% to $3.35 per share next year.

>>To see these stocks in action, visit the 10 Stock Picks From Small-Cap Specialist Royce Funds portfolio on Stockpickr.
Disclosure: TheStreet's editorial policy prohibits staff editors and reporters from holding positions in any individual stocks.

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