Mentor Graphics Corp (MENT), Netflix, Inc. (NFLX): My Top Two Carl Icahn Picks

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Carl Icahn recently battled Michael Dell for Dell Inc. (NASDAQ:DELL), and although Dell won, Icahn still made $70 million in six months.

Icahn is famous for investments like this where he takes an active role in trying to unlock shareholder value, but he is actually a successful value investor with a long history of success. His company, Icahn Enterprises, describes their strategy in simple terms:

“We seek to find undervalued companies in the Graham & Dodd tradition, a methodology for valuing stocks that primarily looks for deeply depressed prices. However, while the typical Graham & Dodd value investor purchases undervalued securities and waits for results, we often become actively involved in the companies we target.”

In addition to reading what they write about their investing philosophy, we are able to watch exactly what large investors do with their money. Large investors, anyone managing at least $100 million, must provide the Securities and Exchange Commission (SEC) with a list of their stock market holding every 90 days.

When looking at Icahn’s investments, we see that he is not as diversified as many other investors. He lists only 19 holdings worth more than $21.5 billion in his SEC filings. Individuals tend to be limited in the number of stocks they can own, so Icahn may be a better model to follow than a hedge fund with hundreds of different stocks.

Despite the small number of holdings, Icahn’s positions are diversified across a number of industries. This is consistent with Icahn’s June company presentation, which notes, “We are a diversified holding company owning subsidiaries engaged in the following operating businesses: Investment, Automotive, Energy, Gaming, Railcar, Food Packaging, Metals, Real Estate and Home Fashion.”

Some investors scour SEC filings to unlock the methods of great investors like Icahn, who has a personal fortune of about $20 billion. I review these filings from a slightly different perspective. The list of stocks Icahn owns is short, but a few of the stocks are bound to be better than others. Because I have limited trading capital, I developed a system to find the best stocks. This is the same system I ran on the list of Warren Buffett’s stocks several months ago.

With Icahn, I found that his stocks offer market-beating returns with an average annual gain of 12.1% a year since the end of 2002, besting the 5.6% annual return from the S&P 500 index.

Right now, two Icahn stocks are strong buys, according to my system.

Hedge Fund StrategiesMentor Graphics Corp (NASDAQ:MENT) provides design software and hardware solutions to automate the design, analysis and testing of complex systems software. Its customers are in the communications, computer, consumer electronics, semiconductor, networking, multimedia, military and aerospace, and transportation industries. Earnings have grown at an average of 38% a year in the past five years, but analysts expect a slowdown and are looking for growth of only 10% a year in the next five years.

Mentor Graphics Corp (NASDAQ:MENT) has consistently beaten analysts’ earnings expectations, and the company’s customers are in industries that Icahn knows well. He might be buying the stock because he believes its products are superior to the competition, or there could be another reason. We don’t know for sure, but we do know that cash flow growth and relative strength (RS) are above average for MENT, making the stock a buy based on my system.

Cash flow is more predictive of a company’s financial health than earnings, and RS shows how a stock is performing compared to the rest of the market. Value stocks can trade at low values for years before other investors catch on. Buying only when RS is high helps avoid this problem. RS is shown as a number between 0 and 100, with 100 being the strongest and 0 being the weakest. High RS means a stock is among the best performers in the market, and Mentor Graphics Corp (NASDAQ:MENT) has an RS rank of 100.

MENT Chart

Netflix, Inc. (NASDAQ:NFLX) is also an Icahn holding. NFLX is a leading provider of Internet entertainment services. Earnings have been volatile. The company beat analysts’ expectations by more than 20% last quarter, but missed expectations by more than 70% the previous quarter. Volatility may continue, but Icahn seems to believe the company will be a winner as the Internet television industry evolves.

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