Hedge funds generate a significant portion of their alpha in their small-cap investments, primarily because there is less publicly available information about these stocks. At Insider Monkey, we’ve empirically tested this phenomenon, and according to our own analysis, investing in hedge funds’ top small-cap picks has generated an alpha of about 120 basis points per month.
We started publishing a quarterly newsletter at the end of August, and since then, until the end of December, this strategy returned 14.3% vs. 2.1% for the S&P 500 index (learn more about our small-cap strategy).
Using our database of 13F filings from the SEC, let’s take a look at one hedge fund in particular: David Abrams’ Abrams Capital Management. We’ll give a brief run-through of the fund’s small-cap holdings (see Abrams Capital Management’s full 13F portfolio). Each has a market capitalization between $1 billion and $5 billion, which is the same criterion used in our market-beating strategy.
Lamar Advertising Co (NASDAQ:LAMR) is Abrams’ No. 1 stock holding overall, worth over 28% of his 13F portfolio at the end of the last filing period. It’s not often that we see a fund with nearly $1 billion in 13F assets under management have such a large percentage of their portfolio invested in one particular small-cap. So, the obvious question is: why is Abrams so bullish on Lamar?
Well, for starters, the billboard advertising company’s industry-level outlook is promising, as it slowly upgrades its ad portfolio digitally. Due to the fact that digital billboards offer ad space to multiple customers, revenue per board is inherently increased. Now, the Street expects this bullish trend to positively impact Lamar’s bottom line, as the average analyst is projecting EPS growth in excess of 100% this year.
Now, it’s worth mentioning that the stock currently trades at a PEG above 2.0, but if it can post Q4 earnings above the 10-cent consensus, there’s more upside to be had. Lamar reports next quarter’s financials on February 27th; we’ll be watching this date closely.
Next up we have Arbitron Inc. (NYSE:ARB), sitting at fourth in Abrams’ portfolio, good for his second favorite small-cap. Arbitron provides market research to players in all aspects of the media world, from mobile advertisers to television networks. The company’s most notable services are audience measurement, local and regional qualitative customer data, and various software programs.
One of the company’s key growth drivers is its ability to install “annual price escalators” in its clients’ contracts. Keeping this in mind, the sell-side expects Arbitron’s earnings growth to accelerate notably over the next five years, forecasting an annual expansion of 13-14%. Over the past half-decade, EPS growth averaged just 2.9% a year. While the value isn’t outstanding—a PEG of 1.7 and a forward P/E of 18.5x—growth-oriented investors can be satisfied with Arbitron.
Which two stocks remain?