The most popular small cap stocks among hedge funds, as determined from quarterly 13F filings tend to outperform the S&P 500 by an average of 18 percentage points per year (learn more about our small cap strategy). We think that this is because small cap stocks receive less attention from large institutional investors such as mutual funds as well as the financial media, and so are more likely to be either overvalued or undervalued. Investors can also take advantage of this finding by reviewing 13Fs from top managers and doing further research on any interesting small cap picks. We have gone through Cliff Asness’s AQR Capital Management’s 13F for the first quarter of 2013 and here are the fund’s five largest small cap holdings as of the end of March (or see the full list of Asness’s stock picks):
AQR owned over 14 million shares of Hudson City Bancorp, Inc. (NASDAQ:HCBK) at the end of the first quarter of 2013. The bank operates in the New York City metropolitan area, and trades right about at the book value of its equity. M&T Bank plans to merge with Hudson City, and while there have been regulatory concerns recent developments have indicated that the deal should be back on. Merger arbitrage can be a useful investing strategy, as the return depend on whether or not the deal closes rather than on market conditions.
Asness and his team had about 4 million shares of GameStop Corp. (NYSE:GME) in their portfolio at the beginning of April. The video game retailer and reseller (though the future of its used game business may depend on how Microsoft decides to treat used games on the Xbox One) has more than doubled in the last year, even as earnings slipped 25% in its most recent quarter compared to a year ago. 36% of the outstanding shares are held short, though analyst expectations imply a forward P/E of 10. Value investor Joel Greenblatt had GameStop Corp. (NYSE:GME) as one of his top picks in his own 13F (find Greenblatt’s favorite stocks).
In the 13F, AQR reported a position of about 14 million shares in Brocade Communications Systems, Inc. (NASDAQ:BRCD), the $2.5 billion market cap data storage company. The second quarter of Brocade’s fiscal year ended in April; while the company grew its net income substantially compared to the same period in the previous fiscal year, revenue was about flat. We’d be concerned, then, that future earnings growth might not be sustainable as it has recently come through margins alone. However, the sell-side is optimistic with Brocade carrying a forward P/E multiple of 8.
Rounding out our list of Asness’s picks in this category is Assurant, Inc. (NYSE:AIZ), an insurance company which focuses on accident and health insurance. At a market capitalization of $3.9 billion, its trailing and forward P/Es are 10 and 9 respectively. With a P/B ratio of 0.8 as well, it is a potential value play though recent performance has actually been weak. Specifically, its last quarterly report showed a 28% decline in net income compared to the first quarter of 2012 despite rising revenue.
Still, we think that Assurant is cheap enough to be worth further research, though of course we would want to see its business improving before making any moves there. American Capital and GameStop Corp. (NYSE:GME) seem like complicated situations- in one case because of the investments in private securities and in the other because of uncertainty regarding what Microsoft will do. It’s certainly possible that American Capital is a value opportunity, however, and while we are highly skeptical of GameStop Corp. (NYSE:GME)’s viability over the long term as more gaming goes electronic it may be worth watching for any upside surprises at the company.
Disclosure: I own no shares of any stocks mentioned in this article.