Joel Greenblatt, the former manager of Gotham Capital, has achieved a more widespread following among investors through his books (including You Can Be A Stock Market Genius) and his “Magic Formula” among other activities (normally this degree of self-promotion worries us, but Greenblatt does actually offer useful lessons). We track Greenblatt’s 13F filings alongside those of hundreds of hedge funds and other notable investors as part of our work developing investment strategies; we have found, for example, that the most popular small cap stocks outperform the S&P 500 by an average of 18 percentage points per year. We attribute this result to large institutional investors such as mutual funds paying less attention to small cap stocks. If small cap stocks are often mispriced, we can scan individual 13Fs for which small caps top managers like so that investors can do further research on any interesting names. Here are Greenblatt’s five largest small cap holdings as of the end of March (or see the full list of his stock picks):
According to the 13F, Greenblatt had close to 300,000 shares of $3.3 billion market cap biotech company United Therapeutics Corporation (NASDAQ:UTHR) in his portfolio at the end of the first quarter of this year. United Thereapeutics is another popular short target, with 17% of the float held by short sellers, despite the fact that its trailing and forward P/Es are 12 and 9 respectively. The sell-side predicts decent earnings growth over the next several years and as a result the stock’s five-year PEG ratio is well below 1.
While the value investor cut his stake in mattress company Tempur Sealy International Inc (NYSE:TPX)- which was known as Tempur-Pedic prior to its acquisition of Sealy- by 22%, the filing still showed a position of about 340,000 shares. Even with earnings down sharply, the stock has come close to doubling in the last year as investors look for this consolidation to help the company. Analyst optimism has given the stock a valuation of 14 times forward earnings estimates, but we’d be a bit worried about potential integration risk and would avoid the stock for now.
Security and intelligence services provider SAIC, Inc. (NYSE:SAI) rounds out our list of Greenblatt’s small cap picks. The company serves a number of government agencies, including the Department of Defense and Department of Homeland Security, among others. Analysts are predicting lower earnings per share next year than what the company has done on a trailing basis- possibly looking to federal spending cuts- and in fact both revenue and earnings were down last quarter compared to the first quarter of 2012. SAIC trades at 9 times trailing earnings, so the market is not looking for much growth here either.
We agree that SAIC’s business is uncertain going forward, and with recent results being weak we are skeptical of it as a potential value despite the low multiples- other contractors might be better options for investors who think the risks of spending cuts are overplayed. We also don’t like Tempur Sealy very much, as we’ve mentioned. In the case of GameStop Corp. (NYSE:GME), we are very wary about how the company would be affected by how next-gen consoles from Microsoft and Sony will affect a brick-and-mortar retail game business (with digital distribution having already negatively impacted its PC game sales) and would avoid that stock as well.
Disclosure: I own no shares of any stocks mentioned in this article.
