Insider Monkey tracks quarterly 13F filings from hundreds of hedge funds, including billionaire Stephen Mandel’s Lone Pine Capital. We’ve found that 13Fs can be useful in developing investment strategies; for example, we have found that the most popular small cap stocks among hedge funds earn an average excess return of 18 percentage points per year. In addition, while we don’t recommend blindly imitating hedge fund managers, their picks can serve as initial investment ideas (similarly to the results of a stock screen) with investors performing further research on any interesting names. Here are our thoughts on three of Lone Pine’s small cap (defined as those with market capitalizations between $1 billion and $5 billion) picks from the first quarter of 2013 (or see the full list of Mandel’s stock picks).
The fund reported owning 3.4 million shares of WABCO Holdings Inc. (NYSE:WBC), a $4.9 billion market cap auto parts company. Specifically, WABCO Holdings Inc. (NYSE:WBC) focuses on braking, transmission, and suspension systems. Many investors like the auto and auto parts industries at this time, believing that since the U.S. auto fleet is old compared to historical averages there is a good deal of pent-up car demand among consumers which could drive strong revenue growth.
Another of Mandel’s small cap picks is $2.4 billion market cap oil and gas transportation, storage, and processing company SemGroup Corp (NYSE:SEMG). A decline in business in Semgroup’s Mexican segment contributed to revenue declining 8% in its last quarterly report compared to the first quarter of 2012. The company earned an increased amount of income from equity investments, however, and so operating income of $22 million was considerably higher than it had been in the prior year period.
The company generated roughly that much cash from its operations, but also invested heavily in capital expenditures and in subsidiaries. It should be noted that a good deal of growth in operating income was driven by the oil segment, and over the long term it is likely that there will be more demand for midstream services as onshore shale plays become more developed in the U.S. Semgroup carries trailing and forward earnings multiples of 36 and 26, respectively, so the company is highly dependent on its business growing over the next several years.
Lone Pine owned 3.5 million shares of Colfax Corp (NYSE:CFX), an industrial machinery and engineering company, at the beginning of April. In the second quarter of 2013, Colfax delivered 3% revenue growth versus a year earlier but significantly cut SGA and interest expenses, resulting in a large percentage increase in net income. The company earned 74 cents in the first half of the year. However, annualizing that figure yields an earnings multiple of 35 at the current valuation. Wall Street analysts are optimistic enough that the forward P/E is only 21, but that seems like aggressive pricing; earnings growth rates are likely to fall in the future, as increasing profits primarily through wider margins should prove unsustainable.
The thesis behind autos is somewhat interesting, though it was noted that thus far demand for light cars has not been growing that quickly and in addition investors may prefer to look at automakers or other auto parts companies rather than WABCO Holdings Inc. (NYSE:WBC). Semgroup and Colfax seem quite expensive in terms of their trailing earnings, and with their recent revenue results not being that good (and with it being unlikely that these companies can get to a reasonable valuation through margins alone) investors should probably avoid those stocks.
Disclosure: I own no shares of any stocks mentioned in this article.
