$21 Billion Hedge Fund Farallon Capital’s High Upside Potential Picks

We have been processing 13F filings from hedge funds in our database, which tracks positions in U.S. stocks over time and which we have used to develop investment strategies. For example, we have found that 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). We can also treat ownership by a hedge fund similarly to a stock screen in that it can present interesting ideas for further research; a hedge fund’s 13F can be thought of as a list of free recommendations. In turn we can combine ownership by a particular hedge fund with other stock screens. While measuring a stock’s upside is challenging, we can screen for one measure of upside potential by looking at the PEG ratio, which puts the stock’s earnings multiple in the context of the consensus earnings growth rate (keeping in mind that analysts are often wrong). Here are four of the largest holdings in Farallon Capital’s most recent 13F with five-year PEG ratios of 1.0 or lower (or see the full list of stocks Farallon reported owning):

The fund initiated a position of 4.3 million shares in Dollar General Corp. (NYSE:DG). The dollar store is still going strong on a financial basis, with double-digit growth rates on both top and bottom lines in its most recent quarterly report (from the quarter ending in early November) compared to the same period in the previous fiscal year. The upside potential thesis comes from an expectation that high growth will continue and a trailing earnings multiple of 18- this represents only a small premium to competitors such as Wal-Mart (NYSE:WMT). Billionaire Stephen Mandel’s Lone Pine Capital increased its stake in Dollar General by 61% in the fourth quarter and reported owning over 13 million shares in its own 13F (find Mandel’s favorite stocks).

FARALLON CAPITALMandel and Farallon also included Priceline.com Inc (NASDAQ:PCLN) among their top picks. Priceline trades at 26 times trailing earnings, and so needs very high growth in order to justify the current valuation let alone provide upside for investors. However, the company has indeed been performing well: net income was up 28% in the fourth quarter of 2012 versus a year earlier, and growth may be supplemented with the acquisition of Kayak Software Corp (NASDAQ:KYAK). Wall Street analysts expect this trend to continue, with consensus implying a PEG ratio of 1.0. Blue Ridge Capital, managed by Tiger Cub John Griffin and his team, owned about 550,000 shares of Priceline at the end of December.

Learn more about two more stocks Farallon liked, including one health care stock that is a hedge fund favorite: