Many large institutional investors such as mutual funds do not consider many small cap stocks for their portfolio due to size or liquidity concerns, and these stocks are often less widely followed by the financial media as well. It is sometimes thought that as a result these stocks are more likely to be mispriced, which is our explanation for why the most popular small cap stocks among hedge funds generate an average excess return of 18 percentage points per year (learn more about our small cap strategy). We can also look at the top small cap picks from individual managers and think of them as initial ideas for investors to research further if they so desire. Here are $2.5 billion AUM hedge fund PAR Capital Management’s five largest holdings in stocks with market caps between $1 billion and $5 billion as of the end of December (or see the full list of stocks the fund reported owning):
PAR disclosed a position of 4.1 million shares in Alaska Air Group, Inc. (NYSE:ALK). The stock is up 78% in the last year, rallying along with many other airlines on hopes that industry consolidation will unlock higher prices. Alaska Air trades at 10 times forward earnings estimates; while cheap in absolute terms, that is a bit higher than where we see other airlines and the company reported a decline in net income in the fourth quarter of 2012 versus a year earlier. Renaissance Technologies, whose founder Jim Simons is now a billionaire, owned 4.2 million shares at the end of December (check out Renaissance’s stock picks).
The fund kept its stake in Avis Budget Group Inc. (NASDAQ:CAR) constant through the fourth quarter of 2012 at 7.4 million shares. The car and truck rental business has also been on a tear over the last year, more than doubling in price. Even so, Wall Street analysts are currently calling the stock undervalued with their consensus forecasts implying a forward earnings multiple of 10 and a five-year PEG ratio of 0.4. David Cohen and Harold Levy’s Iridian Asset Management bought 4.5 million shares of Avis Budget Group Inc. (NASDAQ:CAR) in Q4 after not having owned any shares at the end of September (research more stocks Iridian was buying).
Penn National Gaming, Inc (NASDAQ:PENN), the $4.5 billion market cap gaming facilities operator, was another of PAR’s small cap picks. Many gaming and casino stocks are currently trading at high earnings multiples, and Penn National Gaming is no exception; specifically, the trailing P/E is 29. Revenue growth has been decent, but does not seem to be high enough to justify that valuation and earnings have actually been down. Billionaire Israel Englander’s Millennium Management was buying between October and December and closed 2012 with about 860,000 shares in its portfolio (find Englander’s favorite stocks).
According to the 13F, the fund owned 1.4 million shares of United Rentals, Inc. (NYSE:URI). The equipment rental company is highly exposed to macro conditions with a beta of 3.0. Growth on both top and bottom lines has been very strong- over 40% in its last quarterly report compared to the fourth quarter of 2011- and while the company is dependent on future growth the sell-side is bullish as the forward P/E is only 9. Highbridge Capital Management, managed by billionaire Glenn Dubin, was another major shareholder at the beginning of January (see more stocks Dubin likes).
PAR had about 860,000 shares of Churchill Downs, Inc. (NASDAQ:CHDN) in its portfolio, per the filing. At a market capitalization of $1.2 billion, Churchill Downs trades at 22 times trailing earnings. Not only is that look a bit expensive to us, but financial performance has not been particularly strong lately: sales grew only 6% in its most recent quarter compared to the same period in the previous year, while net income was down substantially. Mario Gabelli’s GAMCO Investors slightly increased the size of its position in Churchill Downs to a total of about 850,000 shares according to its own 13F.
Disclosure: I own no shares of any stocks mentioned in this article.
