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Mark Gomes, PTT Research (1,259 clicks)
Long/short equity, research analyst, tech, IT channel checks
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On Sunday, Seeking Alpha reported that Credit Suisse has issued its top 25 picks to be added and deleted from the Russell 2000. Looking at the selections, we believe Credit Suisse focused on identifying the most likely additions and deletions, as opposed to those that hold the greatest potential for investor profits. This article will discuss the subject in deeper detail.

Buy The Additions?

The top 25 additions were as follows:

ACADIA Pharmaceuticals Inc. (ACAD), Albany Molecular Research Inc. (AMRI), American Realty Capital Properties, Inc. (ARCP), Aviv REIT, Inc. Common Stock (AVIV), BNC Bancorp (BNCN), Christopher & Banks Corporation (CBK), Cutera, Inc. (CUTR), Ducommun Inc. (DCO), Flagstar Bancorp Inc. (FBC), Garrison Capital Inc. (GARS), GenMark Diagnostics, Inc. (GNMK), Global Eagle Entertainment Inc. (ENT), Gray Television Inc. (GTN), Insmed Incorporated (INSM), Lifevantage Corporation (LFVN), Nautilus Inc. (NLS), Pacific Premier Bancorp Inc. (PPBI), PowerSecure International, Inc. (POWR), Puma Biotechnology (PBYI), Remy International, Inc. (REMY), Sarepta Therapeutics, Inc. (SRPT), Tile Shop Holdings, Inc. (TTS), Uni-Pixel, Inc. (UNXL), Vringo, Inc. (VRNG), and West Corporation (WSTC).

In this grouping we see several IPOs (like WSTC) along with companies possessing high market capitalizations and liquidity (like SPRT). Most of the remaining selections are stocks that have already posted massive gains year-to-date (like ACAD, which has run from 4 to 12 since January).

In each of these cases, investors are subject to limited upside or elevated levels of risk. Recent IPOs and highly capitalized stocks tend to be highly liquid. This will make it easy for Russell fund managers to obtain the required number of shares in June. In the case of stocks with strong year-to-date gains, investors are risking 1) that the arbs have already obtained enough shares to sell to Russell managers in June and 2) the potential for any missteps to send the shares markedly lower.

Overall, we agree with Credit Suisse's assessment. We expect the majority (if not all) of its selections to be added to the Russell. However, the opportunity for investors to profit from this information appears low. We believe that more attractive opportunities exist among the other 40+ stocks that we expect to be added to the Russell. Among them, we highlighted Media General (MEG) in March, which subsequently delivered a 50%+ gain. Our newest selection is LCNB Corp (LCNB), which also offers a favorable risk-to-reward profile.

Short The Deletions?

Looking at the company's top deletion picks, we see the follow:

Agenus Inc. (AGEN), AXT Inc. (AXTI), Cadiz Inc. (CDZI), Capstone Turbine Corp. (CPST), Cherokee Inc. (CHKE), Discovery Laboratories Inc. (DSCO), Doral Financial Corporation (DRL), Echelon Corporation (ELON), FuelCell Energy Inc. (FCEL), Golden Minerals Company (AUMN), Gyrodyne Co. of America Inc. (GYRO), Harris & Harris Group, Inc. (TINY), Innodata Inc. (INOD), Intevac Inc. (IVAC), Mattson Technology Inc. (MTSN), Mindspeed Technologies Inc. (MSPD), Neutral Tandem, Inc. (IQNT), Omeros Corporation (OMER), QuickLogic Corporation (QUIK), Rand Logistics, Inc. (RLOG), Rockwell Medical, Inc. (RMTI), The Eastern Company (EML), United States Antimony Corp. (UAMY), and Uranerz Energy Corp. (URZ).

As is the case with the potential additions, we believe this represents a fine list of likely Russell deletions. However, among these, there are a number of companies trading for under $1 (like CPST and FCEL). Others, like RMTI, have already declined by 50% year-to-date. Most of the others possess good liquidity or are poised to report stronger Q1 results. In each of these cases, shorting the stock is either impossible or presents risks that likely outweigh the potential for arbitrage gains.

In contrast, our selections for deletion exhibit greater risk-to-reward characteristics. Thus far, we have reaped 20%+ returns from shorting PDI Inc (PDII). From this point, we expect similar or greater returns from shorting names like Perfumania (PERF). In each case, the underlying company is facing headwinds in its business. Meanwhile, their stocks are suffering from low liquidity and a high number of shares that will need to be distributed by Russell fund managers in June.

More to come…

We'll be issuing many Russell updates in the weeks / months to come. To get the latest picks automatically, simply hit the "Follow" button under my profile photo at the top of the page.

Source: Gaming Who Will Join And Exit Russell

Additional disclosure: I am short PERF.