Warren Buffett’s Top Small-Cap Picks Include USG Corporation (USG), NOW Inc (DNOW), and Media General Inc (MEG)

When it comes to writing about Warren Buffett, a single post may not be sufficient; there is literally so much that can be said and written about the “Oracle of Omaha”. According to Forbes, Warren Buffett has a net worth of $71.2 billion, making him the fourth-richest person in the world and within easy striking distance of second. Meanwhile, the equity portfolio of his holding company Berkshire Hathaway stands at an impressive $107.13 billion as per the latest 13F filing from Buffett for the reporting period of March 31. The legendary investment manager primarily invests in finance, consumer staples, and technology, with his portfolio being highly concentrated: the top ten holdings of Buffett account for 81.89% of his overall portfolio and much of that is in his top five, with Wells Fargo & Co (NYSE:WFC) and The Coca-Cola Co (NYSE:KO) leading the way. However, it’s Buffett’s small-cap holdings in USG Corporation (NYSE:USG), NOW Inc (NYSE:DNOWand Media General Inc (NYSE:MEG) that we’ll discuss in this article, all of which remained untouched by Buffett during the first quarter.

Warren Buffett

First a quick word on why we are interested in the small-cap stock picks of hedge fund managers. In 2014, equity hedge funds returned just 1.4%. In 2013, that figure was 11.3%, and in 2012, they returned just 4.8%. These are embarrassingly low figures compared to the S&P 500 ETF (SPY)’s 13.5% gain in 2014, 32.3% gain in 2013, and 16% gain in 2012. Does this mean that hedge fund managers are dumber than a bucket of rocks when it comes to picking stocks? The answer is definitely no. Our small-cap hedge fund strategy, which identifies the best small-cap stock picks of the best hedge fund managers returned 28.2% in 2014, 53.2% in 2013, and 33.3% in 2012, outperforming the market each year (it’s outperforming it so far in 2015 too). What’s the reason for this discrepancy you may ask? The reason is simple: size. Hedge funds have gotten so large, they have to allocate the majority of their money into large-cap liquid stocks that are more efficiently priced. They are like mutual funds now. Consider Ray Dalio’s Bridgewater Associates, the largest in the industry with about $165 billion in AUM. It can’t allocate too much money into a small-cap stock as merely obtaining 2% exposure would really move the price. In fact, Dalio can’t even obtain 2% exposure to many small-cap stocks, even if he essentially owned the entire company, as they’re simply too small (or rather, his fund is too big). This is where we come in. Our research has shown that it is actually hedge funds’ small-cap picks that are their best performing ones and we have consistently identified the best picks of the best managers, returning 139% since the launch of our small-cap strategy compared to less than 60% for the S&P 500 (see the details).

With 39.00 million shares valued at $1.04 billion, USG Corporation (NYSE:USG) is the largest small-cap holding of Berkshire Hathaway. The building material company has a market cap of $4.12 billion and its shares have grown 3.12% year-to-date. The most interesting financial figure of USG Corporation (NYSE:USG) is its P/E ratio, which stands at 269.75. The building products company was awarded ‘Innovator of the Year’ by The Executives’ Club of Chicago because of its Durock™ Brand EcoCap™ Self-Leveling Underlayment product that can reduce the environmental impact of industrial activity. Gates Capital Management and David Tepper‘s Appaloosa Management are among other major shareholders of the building materials company.

Buffett owns 4.65 million shares of Media General Inc (NYSE:MEG) valued at $76.62 million. The multimedia company has a market cap of $2.16 billion and its shares trade at $16.60 with a P/E ratio of 37.49. Media General Inc is the second-largest local broadcaster in the United States, operating 71 stations in 48 different markets. Media General Inc (NYSE:MEG) acquired Young Broadcasting and LIN Media in the last two years. According to David Cohen of Midwood Capital Management, these acquisitions could help the company’s stock to rise another 50% over the next two years. Media General Inc (NYSE:MEG) reported weak financial results in the first quarter with a net loss of $7.4 million against a profit of $5.38 million year-over-year. Investment managers with substantial stakes in the multimedia company include Highland Capital Management and Mario Gabelli‘s mutual fund GAMCO Investors.

NOW Inc (NYSE:DNOW) ranks as the number three small-cap stock in the equity portfolio of Buffett, with the position housing 1.83 million shares valued at $39.51 million. The oil and gas distributor has a market cap of $2.56 billion and currently trades at $24.93. Again, the P/E ratio for NOW Inc (NYSE:DNOW) is rather high, at 39.80. Just like other energy companies, NOW Inc (NYSE:DNOW) reported weaker-than-expected first quarter financial results. The global oil distributor company reported revenue of $863 million, which is 20% lower than the prior year quarter. At the same time, its profits came short of market expectations also, as the company reported a net loss of $10 million or $0.09 per share against estimates of a $0.06 loss per share. William B. Gray‘s Orbis Investment Management and First Eagle Investment Management are among the major investors of NOW Inc (NYSE:DNOW).

Disclosure: None