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Medivation Inc (MDVN), Frontier Communications Corp (FTR) And More: Hedge Fund Adage Capital Management’s Small Cap Picks

The most popular small cap stocks among hedge funds outperform the S&P 500 by an average of 18 percentage points per year, according to our research on 13F filings (learn more about hedge funds’ small cap picks). We think that this is because small cap stocks, which we define as those between $1 billion and $5 billion in market capitalization, receive less attention from large institutional investors such as mutual funds and so are more likely to be undervalued or overvalued. We can also use our database of 13F filings to see individual funds’ top small cap picks. Read on for the five largest holdings of stocks in that valuation range which Phil Gross and Robert Atchinson’s Adage Capital Management owned at the end of December or see the full list of Adage’s stock picks.

Frontier Communications Corp (NASDAQ:FTR)

The fund increased the size of its position in Frontier Communications Corp (NASDAQ:FTR) by 11% to a total of almost 35 million shares. Frontier Communications Corp (NASDAQ:FTR) is a telecommunications company offering a high dividend yield- over 9% at current prices and dividend levels. However, the company has significantly reduced its quarterly dividend payments to 10 cents per share; they were 25 cents per share three years ago. Frontier Communications Corp (NASDAQ:FTR)’s business has also been in decline, with revenue and earnings slipping, and despite the high yield 22% of the float is held short.

Gross, Atchinson, and their team were buying shares of Armstrong World Industries, Inc. (NYSE:AWI) during the quarter. The $3 billion market cap building materials company focuses on floor and ceiling materials. It’s another somewhat popular short target, with the most recent data showing short sellers responsible for 14% of the float. The markets are pricing in growth, with Armstrong World Industries, Inc. (NYSE:AWI) trading at 23 times trailing earnings, yet revenue and net income were about flat in the most recent quarterly report compared to the fourth quarter of 2011.

Medivation Inc (NASDAQ:MDVN) was another of Adage’s small cap picks. The biotechnology company has developed Xtandi, a drug which is used to treat prostate cancer patients post-chemotherapy, and some analysts are hopeful that the product will be approved for other uses including pre-chemotherapy. As a development state company Medivation Inc (NASDAQ:MDVN) is unprofitable, but the stock price has risen 46% in the last year on optimsm. Billionaire Andreas Halvorsen’s Viking Global reported a position of 3.4 million shares at the end of December (find Halvorsen’s favorite stocks).

Adage slightly cut its stake in Children’s Place Retail Stores, Inc. (NASDAQ:PLCE), a retailer of children’s apparel with a market capitalization of $1.1 billion, but still owned 2.2 million shares. In its most recent quarter, which ended in early February 2013, sales grew 11% compared to the same period in the previous fiscal year though earnings were up a more modest 6%. With trailing and forward P/Es of 18 and 13, respectively, the stock looks to be priced about right in terms of current growth performance.

WABCO Holdings Inc. (NYSE:WBC) rounds out our list of the fund’s five largest holdings in this market capitalization range. The sell-side finds the stock cheap, with a five-year PEG ratio of 0.7 stemming from a trailing earnings multiple of 14 and decent growth expectations. However, the auto parts company’s business has been weak recently, it’s of course tied strongly to the broader economy with a beta of 2.3, and we imagine that many auto related stocks- including the automakers- might make more likely value prospects than WABCO Holdings Inc. (NYSE:WBC).

As such we would avoid WABCO and prefer to consider other companies tied to auto demand. Armstrong and Children’s Place Retail Stores, Inc. (NASDAQ:PLCE) don’t look too attractive in value terms either, and of course investors should be very wary of actually investing in development stage biotech companies. That leaves Windstream, whose dividend payments are certainly risky but may be worth considering as a small, more speculative holding in a large income portfolio which is based in larger and more reliable companies.

Disclosure: I own no shares of any stocks mentioned in this article.