Small-cap stocks don’t get as much attention from most players in the financial world, which often renders them less efficiently priced than larger stocks. As can probably be expected, hedge funds take advantage of this differential, and hence, generate a significant portion of their alpha from the small-caps.
At Insider Monkey, we started publishing a quarterly newsletter at the end of August that follows hedge funds’ top small-cap picks. Since that point, until the end of last month, this strategy returned a 14.3% versus 2.1% for the S&P 500 index (learn more about our small-cap strategy). We’ve also backtested this analysis, and have found that hedge funds’ top small-cap picks have generated an alpha of about 120 basis points per month.
Let’s take a deeper look at one particular fund’s top three small-cap picks: Jamie Zimmerman’s Litespeed Management. Zimmerman’s equity portfolio is rather small, comprising just 13 different positions in total. It is worth mentioning, though, that she was able to generate a 17% return on these investments in the third quarter—the end of the firm’s last filing period with the SEC.
With that in mind, it should also be said that our database of 13F filings makes it possible to generate these findings; see Jamie Zimmerman’s full portfolio here for yourself. Each small-cap stock listed has a market capitalization between $1 billion and $5 billion, as is consistent with our strategy.
Zimmerman’s top small-cap stock pick is Macquarie Infrastructure Company (NYSE:MIC), sitting at No. 3 overall in the money manager’s portfolio. Macquarie is a heavily diversified infrastructure company, with operations in auto parking, airport refueling, and gas delivery. The most attractive aspect of MIC from an investment standpoint is its dividend, which is projected to yield 5.7%. Over the past year, this payout has been boosted by the stock’s appreciation, which has returned a cool 65.6%.
Going forward, it looks as though investors are most bullish about Macquarie’s gas business, and the sell-side expects earnings growth to average 11% a year over the next half-decade. Macquarie’s bottom line has actually shrunk by nearly 20% annually—on average—over the past five years, so this forecast is a welcome turnaround.
Shares of the company currently trade at a mere 11.8 times next year’s earnings, but the stock’s PEG of 5.7 indicates that the markets may be overvaluing its long-term prospects. Ardent investors would be wise to find a more attractive entry point, but it’s worth noting that Wall Street’s average price target is near $51.75, a good 7-8% upside from current levels.
Who’s the best of the rest?