Large institutional investors such as mutual funds tend to be less focused on small cap stocks (which we define as those with market capitalizations between $1 billion and $5 billion), and it’s often suggested that this makes these stocks more likely to be mispriced. Hedge funds who look at these stocks are therefore more likely to find undervalued or overvalued names to trade accordingly. Our research has shown that the most popular small cap stocks among hedge funds, as determined by an analysis of 13F filings, generate an average excess return of 18 percentage points per year; we’ve been live testing this strategy since September 2012, when it has returned 38%. We can also look at small cap picks from individual hedge funds and treat these as initial investment ideas. Read on for our thoughts on billionaire John Paulson’s Paulson & Co.’s five largest small cap holdings by market value as of the end of March (with the exception of the acquired MetroPCS) or review Paulson’s previous filings.
The fund reported a position of 5.9 million shares in AMC Networks Inc (NASDAQ:AMCX), the $4.8 billion market cap owner of cable TV channels including AMC, WE tv, and IFC. AMC has been delivering rapid growth recently: in the first quarter of 2013, revenue rose by 17% versus a year earlier with net income growing by over 40% over the same time frame. However, the market is already pricing in high earnings growth going forward as the stock trades at 31 times trailing earnings. It might be best to wait for more results from the company.
Paulson specialized in merger arbitrage prior to his legendary short of subprime mortgages prior to the financial crisis, but following poor results in macro investments (particularly gold) since then he has become more focused on merger arb again. Another of his large small cap holdings, Mcmoran Exploration Co (NYSE:MMR) is an oil and gas exploration and production company set to be acquired by Freeport-McMoRan Copper & Gold. Freeport-McMoRan is offering $14.75 in cash to McMoRan shareholders in addition to participation in a royalty trust; the stock’s current price is $16.84, implying a significant value for the trust participation.