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By Matt Doiron

Some of the most valuable information from hedge funds and other notable investors comes in the form of the small-cap and mid-cap stocks which they own. These companies often receive less attention from the media and the investment community, so in theory it should be more likely for them to be mispriced relative to their fundamental value. As it turns out, the most popular small-cap picks among hedge funds earn an alpha of 120 basis points per month on average. We expanded on this finding in our August newsletter by listing the most popular stocks in this market cap category and those picks proceeded to return 14% between September and December (read more about our hedge fund small cap strategy).

Of course, blindly following investors isn't necessarily as smart as using their stock picks as free ideas (similar to the results of an investment screen), taking a brief look at the company, and then deciding whether or not it should be researched further. We looked at billionaire Howard Marks' Oaktree Capital Management's most recent 13F filing (see the full list of Oaktree's stock picks) and found three stocks with market caps between $1 billion and $5 billion that it owned at the time. Oaktree is publicly traded as Oaktree Capital Group (NYSE:OAK).

EXCO Resources (NYSE:XCO), an oil and gas exploration and production company focused on U.S. shale plays, was one of Oaktree's top picks with a position of 37 million shares. EXCO is not profitable on a trailing basis, and many market players do not like its current valuation, seeing as 16% of the outstanding shares are held short. Analyst expectations imply a current-year P/E of 20. Wilbur Ross' Invesco Private Capital had the stock as one of its top holdings at the end of the quarter as well, reporting ownership of 32 million shares (find Invesco's favorite stocks). We can compare EXCO to Chesapeake (NYSE:CHK), which had a very stressful 2012 (and is also a short target) but where analysts are slightly more optimistic: the natural gas producer trades at 16 times consensus earnings for this year.

Marks and his team also liked Omnicare (NYSE:OCR), a $4.3 billion market cap provider of pharmacy services primarily to assisted living facilities and other communities. Oaktree had about 680,000 shares of the stock in its portfolio at the end of the quarter according to the 13F. Omnicare is another popular short, with short sellers responsible for 15% of the float. Earnings have been up, though considerable future growth is already priced in to the stock given the trailing P/E of 27. Analyst expectations imply a current-year P/E of 11 and a five-year PEG ratio of 1. Two hedge funds with large positions in the stock at the end of September were Iridian Asset Management and First Pacific Advisors. Iridian, which is managed by David Cohen and Harold Levy, owned 7.7 million shares while First Pacific owned 6.5 million shares. We like the company's business but we are certainly taking note of the premium valuation.

Vishay (NYSE:VSH) was another small cap that Oaktree owned, reporting a position of 2.8 million shares. Vishay is a $1.6 billion market cap semiconductor company whose stock has slumped 11% in the last year. In the third quarter of 2012, revenue was down 10% from a year earlier and with margins contracting net income dropped 56%. However, the earnings multiples are in the low teens and due to a large cash position the EV/EBITDA multiple is a low 2.9x. As a result while the company may not be good quality the stock may be cheap enough to make it worth considering. Chuck Royce's Royce & Associates was another major holder of the stock.

Source: Billionaire Howard Marks' Most Promising Stock Picks