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Can David Einhorn’s Micro-Cap Picks Like Scientific Games Corp (SGMS) and Green Brick Partners Inc (GRBK) Beat the Market?

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There is no such thing as being lucky when it comes to investing in stocks. It’s for this reason that David Einhorn of Greenlight Capital is highly reputed for his success in hedge fund management. The investor-cum-manager, who learnt his tricks from Gary Siegler and Peter Collery, who managed the SC Fundamental Value Fund, is known to employ a strategy that ropes in both long and short-term investment approaches after carrying out extensive market analysis. Einhorn invests in micro-cap, small-cap, and large-cap stocks and has been extremely successful since the firm’s foundation in 1996. As of July 2013, the company boasted 19.5% in annualized returns during the more than 15 years it had been in operation. Reading from Greenlight Capital’s latest 13F filing with the U.S. Securities and Exchange Commission, the fund had a public equity portfolio value of $7.65 billion and was most heavily invested in technology stocks. The firm’s top five micro-cap picks had less than $1 billion in portfolio value in aggregate, and our backtests of Einhorn’s public equity portfolio for the years 1999 through 2012, show that may be a mistake. Einhorn’s top five micro-cap picks delivered 1.21% value-weighted returns per month on average during the period, well above the S&P 500’s average of 0.32% per month and also well above the value-weighted returns of his top five small-cap, mid-cap, and large-caps over the same period. We have already looked at EInhorn’s top small-cap picks, so let’s focus now on the picks that have historically been his best, his top micro-cap picks, which are Green Brick Partners Inc (NASDAQ:GRBK), Civeo Corp (NYSE:CVEO), and Scientific Games Corp (NASDAQ:SGMS).

Greenlight Capital

Professional investors like Einhorn spend considerable time and money conducting due diligence on each company they invest in, which makes them the perfect investors to emulate. However, while Einhorn’s returns have been strong since the inception of his fund, we also know that the returns of hedge funds on the whole have not been good for several years, underperforming the market. We analyzed the historical stock picks of these investors and our research revealed that the small-cap picks of these funds performed far better than their large-cap picks, which is where most of their money is invested and why their performances as a whole have been poor. A portfolio of the 15 most popular small-cap stocks among funds outperformed the S&P 500 Total Return Index by 95 basis points per month between 1999 and 2012 in backtesting. The exceptional results of this strategy got even better in forward testing after the strategy went live at the end of August 2012. A portfolio consisting of the 15 most popular small-cap stock picks among the funds we track has returned more than 142% and beaten the market by more than 83 percentage points since then, and by 4.6 percentage points in the first quarter of this year (see the details).

Let us first consider Green Brick Partners Inc (NASDAQ:GRBK), formerly BioFuel Energy Corp., which is a real estate operator headquartered in Denver, Colorado. Greenlight Capital’s 13F filing showed that it held a total of 15.64 million shares of the company valued at $129.44 million. The company registered $0.20 in earnings per share during the first quarter on revenue of $58.50 million, which fell short of analysts’ estimates of $63.00 million. Green Brick Partners Inc (NASDAQ:GRBK) did manage to put up a solid performance during the quarter however, considering the bad weather that affected the completion of homes and closures. The company’s management believes that it will have better earnings in the coming quarters, considering that it had almost double the starts during the first quarter compared to what it registered in the same quarter last year. Its expansion into new communities is also expected to result in increased revenues for the succeeding fiscal quarters. As such, the company expects between $29 and $32 million in pre-tax profit for the year ending December 31, 2015. For the quarter ended March 31, five hedge funds out of the more than 700 we track had stakes in the company, having an aggregate investment of $183.09 million. Some of the funds that have stakes are billionaire Dan Loeb’s Third Point LLC with 5.24 million shares and billionaire Jim Simons’ Renaissance Technologies with 222,182 shares.

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