The most popular small cap stocks (defined as those with market capitalizations between $1 billion and $5 billion) among hedge funds outperform the S&P 500 by 18 percentage points per year on average (read more about our research on small cap stocks). We think that this is because smaller-cap stocks receive less attention from the financial media and institutional investors such as mutual funds. Hedge funds are therefore more likely to uncover an undervalued-or overvalued- stock when they do research on these companies. As such we think that a screen of a fund’s favorite small cap stocks can serve as a useful source of ideas for further research. Here are five of billionaire Glenn Dubin’s Highbridge Capital Management’s top small cap picks as of the end of December (or see the full list of Dubin’s stock picks):
The fund owned 2.5 million shares of United Rentals, Inc. (NYSE:URI), which rents construction and industrial equipment. With that line of business highly dependent on the macroeconomy, United Rentals’ stock price is very responsive to changes in broader market indices with a beta of 3.0. Revenue and earnings were each up over 40% in the fourth quarter of 2012 versus a year earlier as the company’s financials continued to improve. The forward earnings multiple is 8, but we’d note that earnings will inevitably take a hit whenever the economy next turns down.
According to the 13F, Highbridge had 2.9 million shares of SEI Investments Company (NASDAQ:SEIC) in its portfolio at the end of December. SEI provides wealth management and financial advisory services, and its business has been doing well: in its most recent quarterly report revenue and net income each rose at double-digit rates from their levels in the fourth quarter of 2011. The stock is priced for further growth: its trailing and forward P/Es are 24 and 16, respectively. It might be worth looking into how sustainable its recent growth might be.
Dubin and his team disclosed ownership of 2.2 million shares of Ctrip.com International, Ltd. (ADR) (NASDAQ:CTRP), which provides tour services in China. Ctrip is another stock whose price is dependent on future growth, with a trailing earnings multiple of 26. While revenue grew 29% in its most recent quarter compared to the same period in the previous year, earnings fell by 24%. Bain Capital’s long/short equity hedge fund Brookside Capital owned 5.6 million shares according to its own 13F (check out Brookside’s favorite stocks).
It looks to us like Ctrip and EchoStar need to provide more convincing results in order for us to consider them as good prospects. Pennymac is worth considering as an income stock on the basis of its dividend yield, but income investors should be sure not to invest in too many REITs and overexpose themselves to real estate prices. SEI and United Rentals, Inc. (NYSE:URI) do look a bit speculative when we look at their valuation in terms of trailing earnings but the strength of their recent results suggest they should at least be watched through their next quarterly results.
Disclosure: I own no shares of any stocks mentioned in this article.
