By Matt Doiron
We follow hedge fund activity in general, but we are particularly interested in finding small-cap and mid-cap stocks that hedge funds like. This is because stocks in this valuation range are less followed and covered and so we believe they are more likely to be inefficiently priced. As it turns out, the most popular small-cap picks among hedge funds tend to have an alpha of about 120 basis points per month (read the details here).
Our explanation of these results is that because the rest of the market is not paying attention to these stocks, but a fund's qualified research team is going as in depth as they would for a large-cap or mega-cap stock, any particular fund's small-cap picks are likely to be sources of alpha. Though we wouldn't recommend blindly following any picks from any fund, they may be useful as potential investment ideas that other investors can then evaluate. Here are five stocks which Jeffrey Vinik reported owning at the end of September (see more of Vinik's stock picks) which had market capitalizations between $1 billion and $5 billion at that time:
Vinik's top pick in this valuation range was NovaGold (NG), a $1.3 billion market cap miner producing gold, silver, copper and other metals. He had over 14 million shares of the stock in his portfolio after not owning any at the end of June. The stock price is down 45% in the last year and the company is unprofitable on a trailing basis - analyst expectations are for net losses in the current fiscal year (ending in November 2013) as well. Seth Klarman's Baupost Group owned 21 million shares of the stock (check out Klarman's stock picks).
The 13F reported a position of about 790,000 shares in Westlake Chemical (WLK). Westlake has since crossed the $5 billion market cap threshold after rising 16% since the end of September. The chemicals company's stock has a beta of 2.6, reflecting high dependence on the broader economy, and its trailing earnings multiple of 18 - while not particularly high itself - is higher than the figure at some other chemical companies. Billionaire Dan Loeb's Third Point was buying shares during the third quarter.
Coal stock Arch Coal (ACI) was another new position in Vinik's portfolio, at 7.1 million shares. It is down 50% in the last year as demand for coal has been weak. Many utilities, for example, have been switching to natural gas as a fuel. 20% of the outstanding shares are held short, and analysts actually expect net losses to be higher in 2013 than they were in 2012. We'd also note that Arch Coal, similarly to Westlake, has a beta greater than 2 and so movements in its stock price tend to be correlated with those of the S&P 500.
ANN (ANN), a $1.5 billion market cap women's apparel retailer, was another small-cap stock that Vinik owned. Renaissance Technologies, founded by billionaire Jim Simons, also had a significant position in the stock. In its most recent fiscal quarter (which ended in October), revenue was up 9% from the same period in the previous fiscal year and this helped push net income 26% higher. At 15 times trailing earnings it may be worth further research.
Vinik cut his stake in Core Laboratories (CLB) by 10% but still owned about 310,000 shares of the stock. Core Labs is another stock that has since passed above $5 billion in market cap. The company provides oil and gas services, particularly related to characterizing and analyzing reservoirs. Core Labs carries trailing and 2013 earnings multiples of 25 and 23, respectively, so the market is pricing in considerable growth. However, in the third quarter of 2012, the company did see 21% earnings growth from a year earlier.