By Jake Mann
Louis Navellier, the manager of the Nevada-based Navellier & Associates, is a fund manager that is mimicked by many investors. Navellier's equity portfolio-as measured by his latest 13F filing with the SEC-is worth a little over $3.5 billion, making him one of the largest of the 400-plus money managers we track at Insider Monkey.
While it's tempting to consider looking at his favorite large-cap holdings, we've found that hedge funds' top small-cap picks can outperform the markets by a far superior margin. Generally speaking, smaller stocks don't get as much attention from bankers, analysts, and the rest of the financial world, leaving them less-efficiently priced than their larger peers. Hedge funds take advantage of this phenomenon, and according to our analysis, investing in their top small-cap picks has generated an annual alpha of more than 15 percentage points per month between 1999 and 2009.
We have also teamed up with MarketWatch to create the Billionaire Hedge Fund Index to measure the stock-picking talent of the smart money's top 40 or so fund managers. After a full year of its existence, the results are truly exemplary. In 2012, this index returned 24.3% vs. 16.0% for the S&P 500 ETF. That's an outperformance of 8.3 percentage points (learn more about how to use this market-beating strategy).
Let's take a look at the top small-cap stock picks of Louis Navellier's fund. The stocks listed here had market capitalizations between $1 billion and $5 billion at the end of the third quarter, which is consistent with the criterion used in our strategy (see all of Louis Navellier's stock picks).
SolarWinds Inc (SWI) is Navellier's top small-cap pick, sitting at the No. 72 spot in the fund manager's entire 13F portfolio. Joining Navellier in SolarWinds is a number of top-name investors, including Jim Simons, Richard Driehaus and Israel Englander (see Israel Englander's newest investments). The primary bullish thesis behind SolarWinds is its ability to provide clients with IT software that's at (or close to) par with its larger peers qualitatively speaking, for a fraction of the price. Shares of the tech company have risen by 58.4% over the past 12 months. While there's not much for value-seeking investors to like here, SolarWinds typically beats the Street's earnings estimates, which forecast 21-22% annual EPS growth over the next half-decade.
Genesco Inc. (GCO), meanwhile, is Navellier's second largest small-cap holding. The diversified retailer, most widely known for its Journeys and Lids brands, has had a good 2013. Genesco's stock has already popped 12.8% this year, and momentum is riding high as we approach the company's Q4 earnings release early next month. Genesco has beaten the sell-side's top and bottom line estimates by an average margin of 21.6% in the first three quarters of its 2013 fiscal year, and a generally upbeat apparel environment-most analysts predict mid single-digit growth this year-also warrants investors' optimism. This stock does not pay a dividend, but a forward P/E below 12.0x and a PEG of 0.89 indicate that there's still value to be had here.
Next up we have The Hain Celestial Group, Inc. (HAIN). Shares of this food processing company, which focuses on organic products, rose precipitously over the first half of 2012, but have since fallen off a bit. Hain is down a little over 9% since last October, but now may be a good time to buy on the dip, so to speak. Wall Street expects earnings growth to accelerate over the next five years, forecasting expansion of 16-17% annually, and shares still trade at a 30% discount to the industry's average book valuation. The stock doesn't pay a dividend, but it's one of the best 'growth at a reasonable price' plays in the organic food segment.
Old Dominion Freight Line (ODFL) is Navellier's fourth largest small-cap holding, and has seen its market cap rise by more than 25% over the past six months. The transportation and logistics company has beaten analysts' EPS estimates in the first three quarters of its 2012 fiscal year. Old Dominion reports its Q4 financials later this week, and it's expected to generate 8-10% top and bottom line growth (year-over-year). The stock isn't particularly expensive-trading at a PEG of 1.25 and a forward P/E near 16.0x-so there may more room for appreciation if another positive beat can be generated. It's understandable why Navellier is bullish here, in yet another industry that should see unspectacular, yet solid growth over the next few years.
Lastly, 3D Systems Corporation (DDD) is the fund manager's fifth largest small-cap, and represents a decidedly different play than the aforementioned stocks. To most investors, 3D Systems is the top dog in the high-flying three-dimensional printing market. The company saw its stock price rise by nearly 250% last year, and shares still trade at a 10% discount to closest peer Stratasys (SSYS) on a P/E basis. 3D Systems' diverse product line offers 3D printing solutions for beginners and expert users, and its pricing structure is generally regarded as the lightest on the wallet. Wall Street's average price target on 3D Systems represents a 6-7% upside, but over the long, long run, there may be even more potential here.