Legg Mason’s Top-Performing Small Caps

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Small-cap and mid-cap stocks do not get as much coverage from bankers and third-party analysts, often leaving them less efficiently priced versus larger stocks. Hedge funds sometimes take advantage of this by dedicating their research teams to work on these lower-valuation stocks, and they often earn substantial alpha from their investments. Based upon our analysis of many hedge funds’ small-cap holdings, we’ve determined that the most popular small-cap stocks among hedge funds can earn about 120 basis points of alpha per month. We started publishing a quarterly newsletter at the end of August and shared the stock picks of this strategy. Since then, this method has returned 23.9% vs. 7.4% for the S&P 500 (learn more about our hedge fund small cap strategy here). Along that same vein, here are five stocks which Bill Miller of Legg Mason Capital Management owns as of his recent 13F filing that had market caps between $1 billion and $5 billion and provided huge returns for 2012.

Bill Miller

Bill Miller’s best-performing stock in our small cap range was Exterran Holdings, Inc. (NYSE:EXH). They offer solutions for producing, processing, and transporting oil and gas, primarily in the field of natural gas compression. The stock more than doubled from a year prior, rewarding investors with a 119% gain. As with many of the smaller oil & gas plays, speculation is rampant and can cause such rises without traditional fundamental support. Analysts are a bit burnt out with EXH’s rise and advise a hold from here on out. Billionaire Ken Griffin of Citadel Investment Group has a debt investment in EXH to the tune of $28mm; see his other bond holding here.

Real estate investment company Newcastle Investment Corp. (NYSE:NCT) saw an 85% increase in share price, partly due to the increase in real estate valuations as the residential and commercial markets continue to recover. UBS hopped on the Buy bandwagon in December of 2012, joining Credit Suisse and Barclays as bulls regarding NCT. Not to be ignored, Newcastle’s excellent dividend yield of 8.3% provides investors another reason to jump in. Malcolm Fairbairn of Ascend Capital has done just that, with almost 3mm shares. Check out what else he holds here.

Payment transaction experts FleetCor Technologies, Inc. (NYSE:FLT) was another big winner for Legg Mason, beating the S&P 500 by more than fifty percentage points, helping the stock reach new 52-week highs at its current levels. Hound Partners initiated an almost $100mm position as indicated by their last 13F filing; see what else manager Jonathan Auerbach holds here. Sell-side analysts see the rise as “too much, too quick”, and are expecting the price to drop by a few percentage points to be more in line with valuations. FLT reports earnings on February 7th, so potential investors should be wary as the announcement is right around the corner.

Continue reading to see Miller’s other hot small cap plays.

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