Billionaire David Einhorn's 5 Most Promising Stock Picks

by: Insider Monkey

By Jake Mann

Generally speaking, hedge funds obtain a significant portion of their alpha from small-cap stocks. This makes sense, due to the fact that public research about these companies tends to be less available. According to our own analysis, investing in the most popular small-cap picks among hedge funds has generated an alpha of about 120 basis points per month (read more about our small-cap strategy).

The average investor typically isn't as well versed in the small-cap space, so input from notable investors may be particularly welcome. As is the case with any screening-based strategy, though, it's important to take a longer look at each company, analyzing the qualitative factors that may warrant hedge funds' interest.

Here's a look at David Einhorn and Greenlight Capital's five largest small-cap holdings that had market capitalizations between $225 million and $2 billion at the end of the third quarter (see Einhorn's entire portfolio).

Einstein Noah Restaurant Group (NASDAQ:BAGL) was the 13th largest equity position in Greenlight's latest filing with the SEC, accounting for just over 3% of its 13F portfolio. Einstein operates the Einstein Bros., Noah's and Manhattan Bagel restaurant chains. The company issued a one-time special dividend of $4.00 per share on December 27th of last year, which was a whopping 33.7% yield at the time. Overnight, shares fell close to 24 percentage points, clearly a sign that investors were still looking to avoid a rise in investment tax rates.

Since the start of 2013, shares of BAGL have regained some of this selloff--up 8.5%--but it appears that there's more value in store. The stock currently trades at an earnings growth multiple (PEG) of 0.88; typically any figure below 1.0 signals an undervaluation. This discount flies in the face of rather bullish analyst estimates that expect earnings growth to accelerate over the next five years.

The sell-side forecasts annual EPS growth of 16-17% over this time, which is far above its yearly average over the past half decade of -8.5%. With a projected dividend yield of 3.75%, income-seeking investors can find something to like about Einstein as well, but it's the stock's current valuation that presents the biggest opportunity for appreciation.

State Bank Financial Corp (NASDAQ:STBZ), the holding company for State Bank and Trust, was No. 30 in Einhorn's 13F portfolio. The most compelling bullish thesis for State Bank, which is based in Georgia, is its penchant for acquiring failed banks. According to Barron's, "about 20% of the 404 failed banks in the U.S. since 2008 have been in [...] Georgia." State Bank has worked with the FDIC to complete purchases about a dozen or so times over the past three and a half years.

Most analysts expect this trend in the Empire State of the South to continue, and investors can also get some nice value at the moment. STBZ sports a three-year average price-to-cash flow ratio of 2.2x, nearly one-third that of the U.S. regional banking industry's average.

A position worth a little less than $22 million, Fifth Street Finance Corp. (NYSE:FSC) was No. 31 in Greenlight's 13F. Fifth Street pays a remarkable dividend yield in excess of 10%, and shares have gained 8.6% over the past year. In addition to being a clearly attractive investment from a payout standpoint, Fifth Street also offers solid value at a forward P/E of 9.3x. The company had seen its bottom line shrink by almost 6% a year since 2007, but the sell-side is expecting 6.4% EPS growth over the next year, with long-range estimates averaging 4-5% a year over the next half-decade.

Due to the fact that Fifth Street focuses on making the majority of its loans via first lien debt, there's less macro-related risk than that of some of its BDC (Business Development Corporation) peers.

Republic Airways Holdings Inc. (RJET) is the holding company for Frontier Airlines, Shuttle America, Republic Airline and Chautauqua Airlines. Greenlight held $15.8 million worth of the stock in its latest 13F filing, a position larger than just four of its other stock picks. RJET has already gained more than 36% in 2013 on the back of increasingly bullish prospects of a Frontier spin-off or outright sale.

A recent research note from Imperial Capital mentions, "Contract flying entails less risk and volatility, and has generally commanded a higher multiple," and we'd have to agree. Imperial holds an $11.00 price target on the stock, and at a forward P/E below 6x, there looks to be nice value here. Republic currently trades at a share price around $7.75, and the sell-side expects year-ahead EPS growth in excess of 30%. Deutsche Bank, the other major firm that covers RJET, holds a $12 price target, so there's clearly optimism on Wall Street.

Last but certainly not least, Symmetricom, Inc. (NASDAQ:SYMM) was Einhorn's fifth largest small-cap investment as of his last 13F, sitting at No. 35 in his 38-stock portfolio. It's tempting to take a glance at SYMM's trailing P/E of 29x and consider the stock to be overvalued, but that'd be ignoring the entire picture. The sell-side expects the company to finish FY2014 with a 31-cent EPS, nearly eight times higher than the previous fiscal year. Keeping this forecast in mind, we can see that SYMM trades at a much more attractive forward earnings multiple of 17.5x.

Symmetricom is a stock that has seen relatively unimpressive mid-single digit appreciation (in percentage terms) over the past 12 months, but the proverbial carrot that's hanging in front of investors is its end-to-end 4G/LTE synching capabilities. Symmetricom's presence in the mobile data arena is shaping up to be a solid compliment to its timekeeping segment moving forward.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: This article is written by Insider Monkey's writer, Jake Mann, and edited by Meena Krishnamsetty. They don't have any business relationships with any of the companies mentioned in this article and they didn't receive compensation (other than from Insider Monkey and Seeking Alpha) to write this article.