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Ken Heebner’s Top Stock Picks: Citigroup Inc. (C), Morgan Stanley (MS), and More

We track quarterly 13F filings from hundreds of hedge funds and other notable investors, including Ken Heebner’s Capital Growth Management. According to our research, the most popular small cap stocks among hedge funds generate an average excess return of 18 percentage points per year (learn more about our small cap strategy) and we have been running a portfolio based on this strategy which has outperformed the S&P 500 by 33 percentage points in the last 11 months. We think other strategies are possible as well. We also like to treat filings from individual managers as lists of free investment ideas, and take a brief look at their top picks to see if any look like good values. Read on for our thoughts on Heebner’s five largest holdings as of the end of June or see a history of his stock picks.

Capital Growth Management increased the size of its position in Citigroup Inc. (NYSE:C) last quarter, to a total of 6.9 million shares. Our database of filings shows that Citigroup Inc. (NYSE:C) had been one of the most popular stocks among hedge funds during Q2 2013 (check out the full top ten list). The value case for the bank is that it trades at a discount to the book value of its equity (with a P/B ratio of 0.8) and that assuming earnings increase in line with analyst expectations the forward P/E is 9. Net income was in fact up over 40% in the second quarter of 2013 versus a year earlier, beating expectations.

CAPITAL GROWTH MANAGEMENTAnother megabank, Morgan Stanley (NYSE:MS), kept the #2 place in the fund’s portfolio according to the filing. While it is a pure-play investment bank, in quantitative terms Morgan Stanley (NYSE:MS) looks a lot like Citigroup Inc. (NYSE:C): a moderate discount to book, and while it is not a value stock based on its trailing results conditions have been improving as profits rose over 60% in its last quarterly report compared to a year ago. Expectations for continued growth place the forward earnings multiple at 10. Billionaire Ken Griffin’s Citadel Investment Group had owned over 10 million shares of Morgan Stanley (NYSE:MS) at the beginning of April (find Griffin’s favorite stocks).

Heebner and his team added to their stake in homebuilder Lennar Corporation (NYSE:LEN) and closed June with 6.6 million shares of the stock in their portfolio. Lennar Corporation (NYSE:LEN)’s revenues were up over 50% in its most recent quarter compared to the same period in the previous fiscal year, with pretax profits more than doubling. Of course, Lennar Corporation (NYSE:LEN)’s business is tightly tied to the housing market. 21% of the float is held short as many market players are bearish on the industry. Millennium Management, managed by billionaire Israel Englander, was also buying Lennar last quarter (research more stocks Englander likes).

Whirlpool Corporation (NYSE:WHR), another way to play housing, was another of Capital Growth Management’s favorite stocks with the filing disclosing ownership of 1.8 million shares. With the stock valued at 16 times trailing earnings, and with revenue and margins both growing in recent reports, it looks like an interesting prospect. Wall Street analyst projections- though these should not be taken on faith- imply a forward P/E of 11 and a five-year PEG ratio of only 0.5. Cliff Asness’s AQR Capital Management reported owning about 620,000 shares of Whirlpool Corporation (NYSE:WHR) in its own 13F (see more stocks from Asness’s portfolio).

Heebner apparently likes housing just as much as he likes recovering banks: rounding out our list of his five largest 13F holdings is another homebuilder, D.R. Horton (NYSE:DHI). As with Lennar, D.R. Horton has been seeing significant improvements in its financials compared to the second quarter of 2012 but short sellers remain cautious and so it is a fairly popular short. With the sell-side generally positive on housing, the earnings multiples are quite reasonable: trailing and forward P/Es of 15 and 11 respectively. Given recent results, investors willing to take on the housing related risks may want to learn more.

Disclosure: I own no shares of any stocks mentioned in this article.

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