The most popular small cap picks among hedge funds have an average alpha of 120 basis points per month, according to our analysis, and between September and December a portfolio of hedge funds’ favorite small cap stocks- which we had identified as such in our August newsletter- returned 14% (read more about our hedge fund small cap strategy). Why do small caps do so well, even as hedge funds struggle in general? We think that it is because these stocks receive less coverage from the media and less attention from large institutional investors, and so it is easier for research teams to identify mispricings. As a result we think that small cap stocks can be a particularly interesting area to look at a hedge fund’s publicly disclosed positions and think of them as recommendations for further review (it’s of course unwise to blindly follow anybody). Here are five stocks which billionaire David Harding’s Winton Capital Management owned as of its most recent 13F filing and which had market capitalizations between $1 billion and $5 billion at the time (see more stocks Harding liked):
Winton’s top pick in this valuation range was Molex Incorporated (NASDAQ:MOLX), a $4.8 billion market cap electronics components manufacturer; the fund owned about 900,000 shares of Molex. The second quarter of the company’s fiscal year ended in December, with Molex reporting revenue and earnings growth of about 10% versus a year earlier. The trailing earnings multiple is 17, which seems about in line for that growth rate. Value investor Edgar Wachenheim’s Greenhaven Associates was another fund reporting a position in Molex at the end of the third quarter of 2012 (find Greenhaven’s favorite stocks).
Three more of Harding’s picks, including a newspaper publisher:
$3.7 billion market cap packaging company Bemis Company, Inc. (NYSE:BMS) was another small-cap stock in Winton’s portfolio with the fund reporting a position of about 710,000 shares. In the third quarter of 2012, Bemis’s revenue declined by 5% and combined with weaker margins this brought earnings down by 15%. There is a moderate dividend yield here, close to 3%, and the beta of 0.5 makes it a potential defensive stock. However, the stock does trade at 24 times trailing earnings and combined with its poor recent performance it may be overvalued.
Winton owned about 860,000 shares of NASDAQ OMX Group, Inc. (NASDAQ:NDAQ). Billionaire Ken Griffin’s Citadel Investment Group cut its stake in NASDAQ OMX during the third quarter but still closed September with 1.8 million shares in its own portfolio (check out Griffin’s stock picks). Sales and net income have been down at NASDAQ OMX, falling about 20% in the company’s most recent quarterly report compared to the same period in 2011. The earnings multiples are low- for example, the current-year P/E is only 10- but it might be best to avoid the stock anyway.
Gannett Co., Inc. (NYSE:GCI) rounded out our list of Harding’s small cap picks. The newspaper publisher, which does also have digital and broadcasting business units, actually reported increases in both revenue and earnings in Q3 2012 from their levels in the third quarter of 2011. At 11 times trailing earnings, and with a dividend yield of 4%, it actually looks like it might be worth doing further research on Gannett. Omega Advisors, managed by billionaire Leon Cooperman, owned 4.4 million shares of Gannett at the beginning of October (find Cooperman’s favorite stocks).
Disclosure: I own no shares of any stocks mentioned in this article.
