Hedge funds’ small cap stock picks can be sources of alpha, even when working off of the fairly old information from 13F filings. We have found, for example, that the most popular small cap stocks among hedge funds earn an average excess return of 18 percentage points per year, and our live testing of this strategy which began in September 2012 has since returned 38%. Read more about imitating hedge funds’ small cap picks. Our explanation for this result is that small caps are more likely to be undervalued- or overvalued- because of less attention from mutual funds and other large institutional investors, making it more likely that hedge fund research teams will identify a good value. We can also examine individual funds’ filings as a source of initial small cap investment ideas. Read on for the five largest small cap holdings from billionaire Jim Simons’s Renaissance Technologies as of the end of March or review Renaissance’s stock picks over time.
The 13F showed the fund with 4.5 million shares of Alaska Air Group, Inc. (NYSE:ALK) at the end of the first quarter of 2013. Alaska Air Group, Inc. (NYSE:ALK) experienced a 9% increase in revenue in its most recent quarter compared to the same period in the previous year, but with net margins shrinking the company’s net income actually declined by 10% over the same time frame. While the earnings multiples are low, the same is the case for the airline industry as a whole so there’d have to be something particular to the geographic focus to make Alaska Air Group, Inc. (NYSE:ALK) a buy.
The investment team disclosed ownership of 3.5 million shares of Western Refining, Inc. (NYSE:WNR), an oil and gas refining and marketing company with a focus on the southwestern U.S. The business is expected to see a decline in earnings over the next couple of years, and revenue was in fact down 7% last quarter compared to the first quarter of 2012. That decline is apparently expected to continue: even with a valuation equal to only 9 times forward earnings estimates, 31% of the outstanding shares of Western Refining, Inc. (NYSE:WNR) are held short per the most recent data.
TW Telecom Inc (NASDAQ:TWTC) was another of Renaissance’s small cap picks, as the fund owned 4.7 million shares at the end of March- a 26% increase from three months earlier. The company’s $4.3 billion market cap makes it look quite expensive relative to its earnings numbers, and the valuation doesn’t get much better when we look at cash flow either. Specifically, TW Telecom Inc (NASDAQ:TWTC)’s trailing EV/EBITDA multiple is 10x. That’s a fairly high EBITDA multiple, both in absolute terms and for a telecommunications company, and we’re not sure what the fund sees in this opportunity.
According to the filing, Renaissance increased its stake in Total System Services, Inc. (NYSE:TSS), a $4.5 billion market cap payments processing company, by 5% to 4.3 million shares. Business was essentially flat in the first quarter of 2013, with both top and bottom lines essentially unchanged versus a year earlier. With the stock trading at 18 times trailing earnings, Total System Services, Inc. (NYSE:TSS) is dependent on achieving at least some growth going forward in order to justify the current valuation. As a result we’d avoid the stock at least until Total System Services, Inc. (NYSE:TSS) can show improvements in its financials.
In the case of both Western Refining, Inc. (NYSE:WNR) and Alaska Air, we don’t necessarily have any problems with the valuation in absolute terms- the question is whether these companies are better buys than their peers, as the entire industry is cheap relative to earnings. Domino’s Pizza, Inc. (NYSE:DPZ), as with many quick service restaurants, seems a bit pricy and the same is true of TW Telecom Inc (NASDAQ:TWTC). With Total not looking that attractive either, we aren’t sure any of these small cap picks are particularly exciting.
Disclosure: I own no shares of any stocks mentioned in this article.
