Small and mid-cap stocks don’t get as much attention from bankers, third-party analysts, and the media, which often leaves them less efficiently priced than their larger peers. Generally speaking, hedge funds take advantage of this by dedicating their research teams to work on the little guys, and consequently, they generate a significant portion of their alpha from the small-cap world.
At Insider Monkey, we’ve empirically tested this phenomenon, and according to our own analysis, investing in the hedge fund industry’s top small-cap picks has generated an alpha of about 120 basis points per month. We started publishing a quarterly newsletter at the end of August and shared the stock picks of this strategy. Since then, until the end of December, this strategy returned a whopping 14.3% versus 2.1% for the S&P 500 index (learn more about our small-cap strategy).
Let’s take a look at the top small-cap stock picks of one hedge fund in particular: George Soros’s Soros Fund Management. The stocks presented here have market capitalizations between $1 billion and $5 billion, which is consistent with the criterion used in our strategy (see all of George Soros’s favorite stock picks).
Now, the crux of Adecoagro’s bullish thesis lies in its exposure to one of the best asset classes out there for the long, long run: arable land. The company owns around 40 different farming properties throughout Argentina, Brazil and Uruguay. Though most investors are aware that farmland prices have been skyrocketing in the United States, Brazil, for example, has also seen the average value of its arable land increase by nearly fourfold over the past decade (via Informa Economics FNP). Uruguayan and Argentinian farmlands have experienced a similar boom.
Another benefit of Adecoagro’s portfolio—which is most heavily concentrated in Argentina—is its crop diversity, which reduces its exposure to one commodity in particular, like corn or wheat. At a mere 14.9 times forward earnings, shares of Adecoagro are cheap at the moment, and the sell-side expects the company to finish 2013 with earnings of 63 cents a share—nearly twice its 2012 forecast.
Who’s the best of the rest?
Acacia Research Corporation (NASDAQ:ACTG) is the second largest small-cap stock in Soros’s portfolio, worth a little over 1.1% of his total 13F holdings. The company and its subsidiaries matches patent owners and inventors to corporate partners. Acacia holds 250 different patent portfolios, for use in medicine, media, IT and energy. Oil and gas production is the company’s latest play as we head into the third week of 2013.
Some bears may cry “troll,” while others may believe that its business model is perfectly legitimate, but the fact is this: the number of patent portfolios under Acacia’s banner has close to quadrupled over the past half-decade. The sell-side expects earnings growth of 38% annually through 2017. At a price-to-earnings growth multiple near 0.7, the markets are clearly undervaluing these prospects, and we’ll be watching Acacia’s presence in the energy industry closely. Famed “magic formula” man Joel Greenblatt was also quite bullish on this company in his last 13F filing (see all of Joel Greenblatt’s stock picks here).
Internet-based photo publishing service Shutterfly, Inc. (NASDAQ:SFLY) is George Soros’s third largest small-cap investment. The hedge fund manager owns about 8.4% of Shutterfly’s outstanding shares, with short-sellers shorting another 21% of the company. Despite this abnormally high level of bearish investors, shares of Shutterfly have actually gained 9.2% since the start of the year, on the back of an upgrade from Topeka Capital Markets and the acquisition of ThisLife, a cloud-based media storage provider.
Topeka now holds a $40 price target on the stock, specifically citing the belief “that current competitors will continue to struggle to achieve sustained profitability.” Generally speaking, Wall Street sees an upside of 15-16% from these levels. At depressed book (1.9x) and sales (2.2x) multiples, Shutterfly offers investors value as well.
Cheniere Energy, Inc. (NYSEAMEX:LNG), the liquefied natural gas company, sits at No. 38 in Soros’s 13F portfolio, and is his next largest small-cap holding. Cheniere has been a beast since mid-November, gaining over 40% in value. As its ticker symbol suggests, the company is currently the U.S.’s only approved LNG export terminal. The Department of Energy’s Federal Energy Regulatory Commission believes the site will have the capacity to ship 2.6 billion cubic feet of gas per day when export activity commences in late 2015.
While it remains to be seen exactly how many of Cheniere’s peers—like Dominion Resources (NYSE:D), for example—will gain terminal approval, forward-looking investors can take solace in this exclusivity at the moment.
Last but certainly not least, rounding out our top five is US Airways Group, Inc. (NYSE:LCC). US Airways is closing in on a merger with American Airlines, which if completed, should generate around $500 million in cost savings and additional revenues close to twice this estimate. Up 9.5% in the New Year, investors are certainly cheery on the prospects of a deal being done, but it’s worth noting that in isolation, LCC still trades at a measly 0.18 times sales. The iconic David Tepper and his fund, Appaloosa Management, are also bullish on US Airways (check out David Tepper’s full equity portfolio here).
For more related coverage, continue reading below:
5 Stocks Steven Cohen and SAC Capital Might Be Forced to Sell
Dividend Stocks Growing Faster Than the S&P 500
Morgan Stanley: Is it the Best Bank to Buy?
Disclosure: I have no positions in any of the stocks mentioned in this article
