Hedge funds generate a significant fraction of their alpha from small-cap stocks, primarily because the information surrounding this space is less efficient. At Insider Monkey, we’ve empirically tested this phenomenon, and according to our analysis, hedge funds’ top small-cap picks generate 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).
With this in mind, it’s important to do a fund-by-fund analysis. Let’s take a look at one hedge fund in particular: Robert Karr’s Joho Capital. Using our database of 13F filings from the SEC, we’ll take a look at the fund’s small-cap holdings in its 11-stock portfolio (see Joho Capital’s full fund profile). Each had a market capitalization between $1 billion and $5 billion at the end of the third quarter, which is the same benchmark used in our market-beating strategy.
New Oriental Education & Tech Group (NYSE:EDU) is Karr’s favorite small-cap stock, sitting at the No. 4 spot in the hedge fund manager’s 13F portfolio. The Chinese company provides private educational services, and has lost over 25% of its market capitalization over the past 12 months. Most of this decline occurred last July, when news broke that the SEC was investigating the company’s accounting practices.
Sentiment has since improved over this situation, as the federal agency found no wrongdoing had occurred, but shares of New Oriental still trade at cheap forward P/E (14.8x) and PEG (0.86) multiples. With a long-range annual EPS growth forecast in excess of 20%, this stock represents a nice ‘growth at a reasonable price’ opportunity at the moment.
Next up we have SINA Corp (NASDAQ:SINA), Karr’s second largest small-cap holding. Sina is one of the most dominant Internet companies in China, and is most widely known for its Weibo micro-blogging site. On the whole, analysts expect Sina to generate earnings growth of 23-24% a year over the next half-decade, and the company is coming off of two consecutive quarterly EPS beats. Shares of Sina currently trade at 5.4 times its cash and 3.3 times book, indicating that investors can still snatch up this growth stock at a relatively decent price.
Who’s the best of the rest?