At Insider Monkey we have been touting the advantages of investing in the top small-cap picks of prominent hedge funds since our inception. In this regard, today we decided to take a closer look at billionaire John Paulson‘s stock picks in the small-cap category, according to his fund Paulson & Co‘s latest 13F filing for the reporting period of March 31. These holdings largely remained unchanged over the quarter and included Extended Stay America Inc (NYSE:STAY), Houghton Mifflin Harcourt Co (NASDAQ:HMHC), Grifols SA, Barcelona (NASDAQ:GRFS), and Cobalt International Energy, Inc. (NYSE:CIE).
Paulson set up his own fund in 1994 with the objective of pursuing a merger arbitrage strategy. The money manager didn’t get into the spotlight until his bets against subprime mortgages, the toxic financial derivatives at the heart of the 2008 financial crisis. He also made another $5 billion in 2010 by betting on gold. The market value of Paulson & Co’s public equity portfolio stood at $19.64 billion at the end of the first quarter, with the healthcare sector accounting for 42% of the value of those holdings.
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Paulson & Co is a fund that we have been following for the last couple of years along with over 700 other investment firms. We follow hedge funds because our research has shown that their stock picks historically managed to generate alpha even though the filings are up to 45 days delayed. We used a 60-day delay in our back tests to be on the safe side and our research showed that the 15 most popular small-cap stocks among hedge funds outperformed the S&P 500 Total Return Index by an average of 95 basis points per month between 1999 and 2012. After adjusting for risk, our calculations revealed that these stocks’ monthly alpha was 80 basis points. We have also been sharing and tracking the performance of these stocks since the end of August 2012, during which time they have returned 144%, outperforming the S&P 500 ETF by nearly 85 percentage points (see more details here).
Paulson held 47.66 million shares of Extended Stay America Inc (NYSE:STAY) valued at $930.83 million at the end of March. The stake represented 4.74% of the value of the fund’s public equity portfolio. Although down by nearly 8.6% over the past year, Extended Stay America Inc (NYSE:STAY)’s stock has appreciated by 2.85% year-to-date. The $4.06 billion owner and operator of 682 hotels delivered an EPS of $0.15 for the first quarter, which beat estimates by $0.01. Revenues of $287.6 million were also $1.9 million higher than expectations. The company has been undergoing a brand transformation phase, which included the renovation of hotels that hadn’t received that honour for at least ten years. Extended Stay America Inc (NYSE:STAY) now has a systematic renovation process in place whereby it is typically able to renovate its hotels over the course of three months for $1 million. A total of 39 hotels were renovated during the first quarter. According to Extended Stay America Inc (NYSE:STAY)’s CEO Jim Donald, a renovated hotel sees an eight point improvement in Revenue Per Available Room (RevPAR). Besides Paulson & Co, Mark T. Gallogly‘s Centerbridge Partners is the other leading stockholder of Extended Stay America Inc (NYSE:STAY), owning an identical stake of 47.66 million shares valued at $930.83 million.
Next on the list is Houghton Mifflin Harcourt Co (NASDAQ:HMHC), in which Paulson’s stake remained unchanged during the first quarter at 30.91 million shares, though the value of the position increased substantially to $725.83 million by March 31. Houghton Mifflin Harcourt Co (NASDAQ:HMHC)’s stock is up by a staggering 24.19% so far this year. The $3.69 billion provider of education solutions is set to acquire Scholastic (NASDAQ:SCHL)’s Education Technology and Services business for $575 million. Houghton Mifflin Harcourt Co (NASDAQ:HMHC) estimates cost savings of $10 million to $20 million from the deal, that will be accretive in 2016. Kevin Michael Ulrich and Anthony Davis‘ Anchorage Advisors holds 21.39 million shares of Mifflin Harcourt, the second-largest position after Paulson’s own.
Grifols SA, Barcelona (NASDAQ:GRFS) occupies the third spot among Paulson’s top small-cap picks with the billionaire owning 17.80 million shares valued at $584.08 million as of March 31. The $11 billion healthcare company’s stock has struggled this year, with shares sliding by 5.3%. In contrast, the biotechnology industry is up by 17.63% during the same period. Grifols SA, Barcelona (NASDAQ:GRFS) produces life-saving protein therapies and has three primary divisions: Bioscience, Diagnostics, and Hospital. Israel Englander‘s Millennium Management holds about 1.16 million shares of Grifols SA, Barcelona (NASDAQ:GRFS) valued at $38.04 million.
Paulson held about 41.75 million shares of Cobalt International Energy, Inc. (NYSE:CIE) valued at $392.88 million in his fund’s portfolio at the end of the first quarter. The $4.10 billion exploration and production company has been in his portfolio since the first quarter of 2013. So far this year Cobalt International Energy, Inc. (NYSE:CIE)’s stock is up by nearly 10%. Among other stockholders of the company are Millennium Management and Phil Gross and Robert Atchinson’s Adage Capital Management which own 9.73 million and 3.76 million shares respectively.
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