Has Billionaire Ken Griffin Found Alpha In Small Caps Such As Hillshire Brands Co (HSH)?

We have found that the most popular small cap stocks among hedge funds- as determined by an analysis of 13F filings- outperform the S&P 500 by an average of 18 percentage points per year, and our live testing of this strategy has returned 38% since September 2012. Why do hedge funds’ small cap picks do so well? We think that it is because these stocks generally receive less attention from large institutional investors such as mutual funds, and so are more likely to be either overvalued or undervalued. Read more about hedge funds’ small cap picks. This means that it can also be wise for investors to use small-cap picks as a source of free investment ideas for further research.  Read on for our analysis of billionaire Ken Griffin’s Citadel Investment Group’s five largest small-cap holdings by market value as of the end of March and see Griffin’s previous filings.

According to our database, the fund’s top pick among stocks with market caps between $1 billion and $5 billion was data transfer product company LSI Corp (NASDAQ:LSI), whose semiconductors allow data to be read from or written to hard drives or flash memory. Revenue was down 9% in the first quarter of 2013 versus a year earlier, which contributed to a steep decline in earnings. Wall Street analysts expect LSI Corp (NASDAQ:LSI) to recover, and as a result the forward earnings multiple is only 10, but we’d still be concerned by the company’s recent financial performance.

Citadel owned 3.6 million shares of oil and gas exploration and production company Gulfport Energy Corporation (NASDAQ:GPOR), which focuses on Gulf Coast acreage as well as onshore U.S. shale plays including the Utica, Bakken, and Niobrara. The stock price has more than doubled in the last year, bringing Gulfport Energy Corporation (NASDAQ:GPOR)’s earnings multiples up quite a bit- currently, the stock trades at 24 times consensus earnings for 2014. 11% of the float is held short as a number of market players consider Gulfport Energy Corporation (NASDAQ:GPOR) overvalued, and it does seem speculative even for an emerging oil and gas company.

Griffin and his team were buying SM Energy Co. (NYSE:SM) during Q1, closing March with 2.1 million shares in their portfolio. Another E&P company, which also has roots in shale acreage (specifically, in the Eagle Ford and Bakken), SM Energy Co. (NYSE:SM) grew its revenue by 30% last quarter compared to the first quarter of 2012 but net income declined by over 30%. This reflects the company’s increased production, particularly of natural gas, which is currently much cheaper in terms of energy equivalent than crude oil due to high supply.

Halcon Resources Corp (NYSE:HK) was another of Citadel’s small cap picks with the filing disclosing ownership of close to 16 million shares. Similarly to the other two E&P companies we’ve discussed, Halcon Resources Corp (NYSE:HK) focuses on the Bakken, Eagle Ford, and Utica shale plays. The business has seen very low profits on a trailing basis, even adjusted for special items. The sell-side is extremely bullish, with projected earnings for 2014 implying a forward P/E of only 8 and with the five-year PEG ratio being 0.6, but it would be risky to take these forecasts at face value.

Rounding out the fund’s five largest small cap holdings was Hillshire Brands Co (NYSE:HSH), even after Griffin slightly trimmed his stake during Q1. The food company primarily provides meat products (including under the Jimmy Dean and Ball Park brands). Food stocks are hot in the current market, with earnings multiples generally being high in absolute terms as investors chase low betas (or attempt to follow Warren Buffett, whose Berkshire Hathaway is acquiring Heinz). Hillshire Brands Co (NYSE:HSH) is no exception, with the stock currently valued at a forward P/E of 20. Billionaire John Paulson’s Paulson & Co. cut its stake by 41% during Q1, but still owned 3 million shares at the end of March (check out Paulson’s stock picks).

We aren’t too sure of either case for Hillshire Brands Co (NYSE:HSH), and would avoid the stock. LSI Corp (NASDAQ:LSI) is in need of a turnaround, and while it could be worth watching the recent financials don’t suggest that the company is doing well right now. As for the E&P companies, the projections for Halcon Resources Corp (NYSE:HK)’s future earnings are quite strong, and so that company might be worth a look though of course oil majors aren’t exactly expensive in the current environment and may offer more stability.

Disclosure: I own no shares of any stocks mentioned in this article.