Our research from our database of 13F filings indicates that the most popular small cap stocks (which we define as those with market capitalizations between $1 billion and $5 billion) among hedge funds outperform the S&P 500 by an average of 18 percentage points per year (learn more about our research on small cap picks). We think that this is because small cap stocks are less widely owned by large institutional investors such as mutual funds, and less covered by the financial media; as a result hedge funds are more likely to uncover an undervalued (or overvalued) stock when looking in this range. Hedge fund small cap picks can therefore serve as a useful screen, identifying ideas for further research. Here are four small cap stocks which Kahn Brothers, managed by Irving and Thomas Kahn, owned at the end of December (or see the full list of stocks the fund reported owning); the fund mostly makes small changes on a q/q basis:
One of Kahn Brothers’ top five picks was The New York Times Company (NYSE:NYT), with a position of 4.8 million shares. Despite the troubled newspaper industry, the stock price has rallied 52% in the last year though this still leaves it down about 50% from its levels five years ago. In addition, the stock trades at 23 times forward earnings estimates- a level which seems quite high to us. Billionaire Ken Griffin’s Citadel Investment Group increased its stake in the The New York Times Company (NYSE:NYT) in the fourth quarter of 2012, to a total of 4.1 million shares (find Griffin’s favorite stocks).
Patterson-UTI Energy (NASDAQ:PTEN) was another of Kahn Brothers’ small cap picks. The company provides contract drilling services to North American energy companies, and has actually seen weaker financials recently: in its most recent quarter, sales were down 10% compared to the same period in the previous year and this pulled net income down by over 30%. Analyst expectations are for earnings to be a bit lower in 2014 than in 2012, though the forward P/E is still near value territory at 14. The most recent data has 11% of the float held short.
Another popular short target which the fund liked during Q4 was MBIA Inc (NYSE:MBI), with the filing disclosing ownership of almost 3 million shares but short sellers accounting for 16% of the float. MBIA carries a significant discount to the book value of its equity, with a P/B ratio of 0.7. However, looking at the company’s capital structure we can see that it is highly levered; possibly because of this, the stock’s beta is quite high at 2.2, suggesting that MBIA is vulnerable to a bear market. So we would be careful when trying to determine if it is actually undervalued.
Old Republic’s dividend yield is high enough that it’s probably worth investigating for income investors, though it would be important to see his safe the dividend payments are given the questionable financial conditions. The New York The New York Times Company (NYSE:NYT) is just not in an attractive industry, and given the high earnings multiples we don’t think that it is a good buy. In the case of Patterson-UTI Energy (NASDAQ:PTEN), we would avoid the stock at least until the company showed more stable financial performance and even then it might be better to look at the energy companies directly.
Disclosure: I own no shares of any stocks mentioned in this article.
