In the stock market universe, small-caps don’t get as much attention from investors, which often leaves them less efficiently priced than their larger peers. As one would reasonably expect, hedge funds seek to take advantage of this, by dedicating their research teams to work on these lesser-known investments.
Interestingly, retail investors can use hedge funds’ top small-caps as a market-beating strategy; our analysis shows that the most popular small-cap stocks among hedge funds can earn about 120 basis points of alpha per month. We started publishing a quarterly newsletter at the end of August and since then, until the end of December, this strategy returned 14.3% vs. 2.1% for the S&P 500 index (learn more about our hedge fund small cap strategy).
With this in mind, it’s important to perform a fund-by-fund analysis, and in this article, we’re going to take a look at Christian Leone’s Luxor Capital Group. Leone has an equity portfolio in excess of $2 billion (see the mammoth fund’s entire profile), but let’s just concentrate on Luxor’s top five small-cap holdings. Each stock had a market capitalization between $1 billion and $5 billion at the end of the third quarter, as is consistent with our strategy.
First up on our list is AMC Networks Inc (NASDAQ:AMCX), which is actually the No. 1 stock pick on Luxor’s entire 13F filing. The entertainment company holds a robust programming portfolio, which includes AMC, WE tv, IFC and independent filmmaker IFC Films. Last year’s snafu with Dish Network (DISH) briefly spooked investors, as the majority of AMC’s revenues are derived from affiliate fees.
Still, since both sides settled their dispute in late October last year, shares of AMCX are up more than 22%. A massive third quarter earnings beat a couple weeks later also had investors feeling cheery. The company identified two key takeaways in their conference call: (1) near-50% viewership growth in the newest seasons of Breaking Bad and The Walking Dead, and (2) increased licensing revenues from content partners like Netflix (NFLX).
It appears that the sell-side is optimistic on AMC’s prospects moving forward; they’re expecting about 20% annual EPS growth over the next half-decade. At a PEG near 1.2, investors aren’t over-hyping this potential, and the company’s focus on quality original programming isn’t going away any time soon.
Luxor Capital’s second favorite small-cap stock is The Madison Square Garden Co (NASDAQ:MSG), sitting at the No. 2 spot in Luxor’s portfolio. Even though there’s no more Linsanity in the Big Apple, MSG seemingly cannot be stopped. The stock has generated a positive return in 9 out of the past 12 months, and is already up over 9% year-to-date. The company’s media segment is the strongest area of MSG’s business, driven by above-average fan interest in the New York Knicks, and the launch of Fuse News.
Wall Street’s average price target on MSG ($48.12) is nearly at parity with the stock’s current market price, and a forward P/E in the upper 20s indicates that investors may be best served by waiting for a more attractive entry point. Interestingly, Mason Hawkins and Southeastern Asset Management hold a position in MSG that rivals Luxor’s (check out Mason Hawkins’ favorite stock picks).
What about the rest of Luxor’s top five?