What's Impacting Small-/Mid-Cap Investing?

Gregory McCrickard Heather McPherson David Wagner David Wallack Brian Dausch (moderator)

BRIAN C. DAUSCH, CFA

portfolio specialist

14 years of investment experience, 13 with T. Rowe Price Portfolio specialist in the Equity Division of T. Rowe Price since 2007

J. DAVID WAGNER, CFA

portfolio manager

12 years of investment experience, 11 with T. Rowe Price Portfolio manager of the U.S. Smaller Companies Strategy since 2007

GREGORY A. MCCRICKARD, CFA

portfolio manager 27 years of investment experience, 25 with T. Rowe Price Portfolio manager of the Small-Cap Core Strategy since 1992

DAVID J. WALLACK
portfolio manager

22 years of investment experience, 21 with T. Rowe Price Portfolio manager of the Mid-Cap Value Strategy since 2000

HEATHER K. MCPHERSON
portfolio manager

11 years of investment experience, 9 with T. Rowe Price Associate portfolio manager of the Mid-Cap Value Strategy since 2005

Agenda
Why do small- and mid-caps make sense in a diversified portfolio? Outlook for small- and mid-caps relative to large-caps is mixed
Valuations Fundamentals Performance cycles

Trends and opportunities

IPO and M&A activity Growth vs. value Pockets of opportunity

Small- and Mid-Caps Have Outperformed, but Performance Comes in Cycles

As of 30 September 2011

Annualized Asset Class Returns and Standard Deviation Since 19261

Returns Standard Deviation

30% 24 18 12 6 0
U.S. Small-Cap Equities
190 170 150 130 110 90 '50
1 Precious

U.S. Mid-Cap Equities

U.S. Large-Cap Precious Metals Equities

Corporate Bonds

Cash

Relative Performance of Small-Caps Versus Large-Caps

Recessions Small-Cap/Large-Cap Relative Strength

Small-Caps Outperform

Small-Caps Underperform

'54

'58

'62

'66

'70

'74

'78

'82

'86

'90

'94

'98

'02

'06

'10

Metals Returns only since 1947. All returns are annualized returns from 1926-September 30, 2011, except Precious Metals, which is from 1947-September 30, 2011. Equity returns based on Center for Research in Security Prices, University of Chicago Data, Large: Decile 1, Mid: Decile 2 and 3, Small: Decile 4 and 5. Precious Metals Returns based on CRB CCI Precious Metals Index. Bonds based on U.S. IT Government Index from 1926-1972, Lehman Bros. Government Corporate Index from 1973-1975, Barclays Cap. U.S. Aggregate Index from 1976-September 30, 2011. Cash based on 30-day T-bill yield. Sources: CRSP Center for Research in Securities Prices-Graduate School of Business, University of Chicago, T. Rowe Price, The Leuthold Group October 2011 Past performance cannot guarantee future results. These charts are shown for illustrative purposes only and do not represent the performance of any specific security. Unlike U.S. Treasuries and corporate bonds, stocks are not guaranteed as to the timely payment of interest and principal.

Small- and Mid-Caps Make Up a Large Part of the Worlds Investable Universe
30 September 2011

World IndicesMarket Capitalization Total Market Value (U.S. $ Trillions)

MSCI EM Index FTSE 100 Index TOPIX DAX Index CAC 40 Index Russell 2500 Index Russell 3000 Index S&P 500 Index MSCI World Index

3.1 2.1 1.3 0.6 0.7 2.2 12.6 10.3

Emerging Markets Various Developed Markets

U.S.

21.1
5 10 15 Trillions 20 25

World Market
30 35

$0

Small- and Mid-Caps Are Often Underfollowed, Which Creates Opportunity

30 September 2011

Total Market Value ($ Billions) of All Companies in Market-Cap Bucket

Market-Cap Bucket ($ Millions)

$0
Smallest 0-1,000 Mid 1,000-10,000 Largest Over 10,000

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

10,000

11,000

Number of Companies Market-Cap

500

1,000

1,500

2,000

2,500

3,000

Number of Companies

Average Number of Sell-Side Analysts Covering a Stock by Size

25
Average Number of Sell-Side Analysts

20 15 10 5 0

21 14 8 4

Large

Mid

Merrill Lynch Size Composites

Small

Micro

10

Sources: FactSet, Merrill Lynch Small-Cap Research Reprinted by permission. Copyright 2011 Merrill Lynch, Pierce, Fenner & Smith Incorporated. The use of the above in no way implies that Merrill Lynch endorses the views or interpretation or the use of such information or acts as any endorsement of T. Rowe Price use of such information. The information is provided as is, and Merrill Lynch does not warrant the accuracy or completeness of the information.

Small-Cap Relative Valuations Do Not Look Cheap

As of 30 September 2011

New Horizons Fund Relative P/E

P/E Ratio of the Fund's Portfolio Securities relative to the S&P 500 P/E Ratio
2.5 2.0 1.5 1.0 0.5 0.0
19 67 19 73 19 97 19 79 19 61 19 85 19 91 20 03 20 0 20 9 11

The New Horizons Fund relative P/E compared to the large-cap-dominated S&P 500 is at a 25-year high.
11
The funds P/E ratio is an average, unweighted number based on 12-month forward earnings per share as estimated by the funds investment manager at each quarter-end. The funds P/E ratio is representative of small cap stock valuations and is shown for illustrative purposes only. This is not intended to be an offer of the New Horizons Fund.

Is Small-Cap Earnings Momentum Shifting?

As of 30 September 2011

Median Operating Earning Momentum Largest 3,000 Companies

Q2 2011 Median Year-Over-Year Operating Earning Momentum Mega-Caps (Top 50) Bottom 2,000 Large-Cap (Top 300) Mid-Cap (Next 900) Small-Cap (Next 1,200) Micro-Cap (Last 600) 17.2% 17.3 18.7 24.3 17.3 12.7 18.0% 20.2 18.9 22.2 22.3 15.3 18.0% 27.0 18.6 24.1 24.9 31.1 13.6% 24.7 18.7 22.3 23.1 27.5 14.4% 31.4 23.0 30.9 31.5 30.7 Q1 2011 Q4 2010 Q3 2010 Q2 2010

Small-cap earnings growth has decelerated. Large- and mid-cap earnings momentum has slowed, but not as much.

12

Source: The Leuthold Group, October 2011

What Does a Bear Market Tell Us?

30 September 2011

Economic Versus Non-Economic Bear Markets Dow Jones Industrials, 1899 to Present Date of High Economic Bear Markets (Decline Occurring Prior to or During U.S. Recession) Non-Economic Bear Markets (Market Decline Not Associated With U.S. Recession) Latest Decline (DJIA) Russell 2000 29 April 2011 29 April 2011 Medians: Date of Low 1899 to Date 1945 to Date Medians: 1899 to Date 1945 to Date 3 October 2011 3 October 2011 Pct. Decline -36.9% -30.0 -27.1 -26.9 -16.8 -29.1 Duration (Months) 21.9 18.1 6.5 6.0 5.0 5.0

Non-economic bear markets have been much shorter than recession-induced ones, but they have inflicted almost as much damage.

If we are heading for an economic recession, we are likely to see more turbulence. Non-economic recessions have been much shorter lived, which could signify that an upturn is on the horizon.
13
Source: The Leuthold Group, October 2011

IPO Market Has Been Relatively Quiet

30 September 2011

Proceeds (in millions of $)

IPO Market Trends Proceeds

30,000 25,000 20,000 15,000 10,000 5,000 0 3Q95 3Q97 3Q99 3Q01 3Q03 3Q05 3Q07 3Q09 3Q11

IPO Market Trends Number

300 250 200 150 100 50 0 3Q95 3Q97 3Q99 3Q01 3Q03 3Q05 3Q07 3Q09 3Q11 Number of IPOs
14

Sources: Securities Data Corp., FactSet Research Systems, BofA Merrill Lynch Small-Cap Research

Small-Cap Cycle: Value vs. Growth

As of 30 July 2011

Performance of Russell 2000 Value Versus Russell 2000 Growth

4.50 4.00 3.50 3.00 2.50 2.00 1.50 1.00 0.50 0.00

78

84

81

87

93

05

02

90

08

96

99

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15

Past performance cannot guarantee future results. Sources: Russell Investment Group, BofAML Small-Cap Research It is not possible to invest directly in an index. These charts are shown for illustrative purposes only and do not represent the performance of any specific security.

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Mid-Caps Have Enjoyed Strong Relative Performance

30 September 2011

2,000 1,800 1,600 1,400 Index Level 1,200 1,000 800 600 400 200 0

Performance Comparison: Russell Mid-Cap Index Versus S&P 500

Russell Mid-Cap Index S&P 500

85

87

91

97

01

05

99

03

07

09

89

93

95

ec -

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16

Past performance cannot guarantee future results. Source: T. Rowe Price It is not possible to invest directly in an index. These charts are shown for illustrative purposes only and do not represent the performance of any specific security.

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The Mid-Cap Average Is, at Best, Valued Comparably to Large-Caps

30 September 2011

Russell Mid-Cap vs. Russell Large-Cap

EV/Sales
1.40

Average
1.20 1.00 0.80 0.60 0.40 12/31/78 12/31/83 12/31/88 12/31/93 12/31/98 12/31/03 12/31/08

Trailing 12-m P/E

1.40

Average
1.20 1.00 0.80 0.60 0.40 12/31/78
17
Source: T. Rowe Price

12/31/83

12/31/88

12/31/93

12/31/98

12/31/03

12/31/08

The Mid-Cap Average Is, at Best, Valued Comparably to Large-Caps

30 September 2011

Russell Mid-Cap vs. Russell Large-Cap

Dividend Yield
1.80 1.60 1.40 1.20 1.00 0.80 0.60 12/31/78 12/31/83 12/31/88 12/31/93 12/31/98 12/31/03 12/31/08

Average

Price/Book
1.40

Average
1.20 1.00 0.80 0.60 0.40 12/31/78
18
Source: T. Rowe Price

12/31/83

12/31/88

12/31/93

12/31/98

12/31/03

12/31/08

Growth has Been Outperforming Value Among Mid-Caps

As of 30 September 2011

Mid-Cap Value Versus Mid-Cap Growth Performance

160 140 120 Index Level 100 80

Growth Value Growth

134 132 130 Index Level 128 126 Jan-03 124 122 120 118 Sep-09 Mar-10 Sep-10 Mar-11 Sep-11

60 40 20 0 Jan-97 Jan-99 Jan-01

Jan-05

Jan-07

Jan-09

Jan-11

Growth

19

Past performance cannot guarantee future results. Source: The Leuthold Group, October 2011 These charts are shown for illustrative purposes only and do not represent the performance of any specific security.

Is Cash the Next Catalyst for M&A Growth?

Cash

M&A Deal Volume

10 8 6 4 2 0

68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10

Debt as Percentage of Total Assets (S&P 500)

38% 36 34 32 30 28 26

The average is 32.9%

1 Largest

20

1,500 stocks, excluding financials, utilities, and autos. Data smoothed on a trailing twelve-month basis. Sources: MergerStat, Corporate Reports, Empirical Research Partners Analysis, FactSet, JP Morgan.

19 95 19 96 19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 20 09 20 10 C ur re nt

Cash and Equivalents as a Share of Balance Sheet Assets1

1,600 1,400 1,200 1,000 800 600 400 200 0

Volume of U.S. M&A Transactions

12