Billionaire Wilbur Ross's Top Small-Cap Picks

 |  Includes: AGO, AL, BKU, KEG, XCO
by: Insider Monkey

By Jake Mann

Wilbur Ross, the manager of WL Ross & Co, has the characteristics of a value investor but specializes in distressed scenarios, and has been the "King of Bankruptcy" by Fortune. In the most recent financial crisis, Ross teamed up with Invesco to buy U.S. banks' toxic assets, and WL Ross is now a unit under the company's umbrella, having amassed assets under management greater than $9 billion.

While most investors would probably focus on Ross's large-cap investments, our research shows that the most popular small-cap stocks among hedge funds have outperformed the market by more than 15 percentage points per year over the long run (see the details here). This makes intuitive sense, as smaller stocks typically receive less attention from bankers, analysts and the rest of the blogosphere.

With this in mind, let's take a look at the top five small-cap picks in Wilbur Ross's portfolio by using data from his latest 13F filing with the SEC (see Wilbur Ross' full equity holdings). Each stock listed here had a market capitalization between $1 billion and $5 billion at the end of the third quarter, which is the same standard used in our research mentioned above. Each represents an intriguing stock for individual investors to mimic, or "monkey," so to speak.

BankUnited (NYSE:BKU) is Ross's top small-cap stock pick, and is actually the No. 1 holding in his entire 13F portfolio. According to our records, the fund manager first reported a position in BankUnited in the first quarter of 2011, and over the past 12 months, shares of the bank holding company have gained 12.6%. Fueled by double-digit net interest income growth and top-tier asset quality, BankUnited has topped Wall Street's earnings estimates in three consecutive quarters. The stock trades at 9% discount to its industry's average on a P/E basis, and a dividend yield near 3% will attract income-seeking investors as well. Joining Wilbur Ross in BankUnited is Ken Griffin's Citadel Investment Group (check out Citadel's entire equity portfolio here).

Assured Guaranty Ltd. (NYSE:AGO), meanwhile, is Ross's second largest small-cap holding. The holding company's subsidiaries offer credit-related services to a wide range of clients, and its shares are up more than 25% since the start of the year. Assured Guaranty will report its fourth quarter earnings in about a month's time, and it appears that investors are optimistic, as the company is coming off of two straight EPS beats. There's still room to run here, as the insurer trades at a paltry PEG ratio of 0.6 and a mere 0.7 times its book value. It's hard to fault Ross here.

Next up we have EXCO Resources Inc (NYSE:XCO), which has been a long-term favorite of Wilbur Ross since at least the end of 2010. Shares of this oil and gas company have been hurt by generally depressed natural gas prices, but ardent investors betting on a rebound might be smart to snatch up this highly leveraged player. This leverage isn't limited to debt-Exco also has more than 95% of its reserves in natural gas. At a price-to-book of 3.3x, Exco isn't particularly cheap, but a decent dividend yield (2.5%) offers some solace to those banking on a natural gas bounce.

Air Lease Corp (NYSE:AL), the fourth largest small-cap holding in Ross's portfolio, and is a great way to play another recovery-this time in the airline industry. As its name suggests, Air Lease is in the business of leasing commercial aircraft, and as Ross's conviction suggests, it has been a great investment of late. Shares of the company have risen nearly 20% over the past six months, and three consecutive double-digit earnings beats have investors clamoring for its Q4 (FY2012) financials next month. At a PEG near 0.5 and a book value per share only slightly above parity with its price, Air Lease offers outstanding value at the moment.

Key Energy Services, Inc. (NYSE:KEG) is Ross's fifth favorite small-cap, and the oil well servicer has been a staple in his portfolio since we began tracking the fund in late 2010. Key Energy's stock price is already up 14.8% year-to-date, and Mr. Market is anxiously anticipating the company's full-year FY2012 results, which are ironically reported on Valentine's Day. Two earnings whiffs in its past four quarters give investors cause for concern, but a Q4 beat should push value-seekers into the stock. Key Energy's current share price is about 20 cents less than its book value per share ($8.19), which is hard to fathom in any industry that's bullish in the long, long run.

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.