Small cap stocks, those with market capitalizations between $1 billion and $5 billion, generally receive less attention from large institutional investors and the financial media. As a result, they should be more likely to be mispriced- either overvalued or undervalued- and in fact we have found that the most popular small cap stocks among hedge funds generate an average excess return of 18 percentage points per year (learn more about our small cap strategy). Investors can also make use of the theory that hedge funds are likely to identify value in small caps by reviewing their top picks in this area and treating the results similarly to a stock screen, performing further research on any interesting names. Here are five small cap stocks which billionaire Israel Englander’s Millennium Management owned at the end of December (see more stocks that Englander reported owning):
One of the fund’s top picks was Ocwen Financial Corp (NYSE:OCN), which originates and services residential loans (including subprime loans). The stock is up almost 150% in the last year; revenue and earnings have been increasing rapidly, possibly in part because of acquisitions. The sell-side actually thinks Ocwen Financial Corp (NYSE:OCN) is still underpriced, as consensus earnings for 2014 imply a forward P/E of only 7. Of course, the nature of the business does indicate some risk related to the housing market. Billionaire Julian Robertson cut his stake between October and December but Ocwen Financial Corp (NYSE:OCN) was still one of his top picks as well (find Robertson’s favorite stocks).
Millennium more than doubled its stake in mortgage servicing company Home Loan Servicing Solutions Ltd (NASDAQ:HLSS) and owned 2.4 million shares as of the beginning of January. At current prices and going by recent dividend payments, Home Loan Servicing Solutions Ltd (NASDAQ:HLSS) pays a dividend yield of over 6%. The stock is up 65% in the last year, driven by the same fundamentals which have carried Ocwen Financial Corp (NYSE:OCN) higher, and while we would again be cautious the high yield should make it worth a look for income investors. Pine River Capital Management, managed by Brian Taylor, was another major shareholder in the company.
Eagle Materials, Inc. (NYSE:EXP), a $3.2 billion market cap provider of cement and other construction materials, was another of Englander’s small cap picks. Eagle Materials, Inc. (NYSE:EXP) is another stock which has risen strongly in the last year (up 86%), is tied to the housing market, and has some quite optimistic expectations from Wall Street analysts. Specifically, the forward P/E is 23 and even if the company hits earnings targets it would still require strong growth from that point. Point State Capital, managed by several former portfolio managers at Duquesne Capital, was buying shares in Q4 (research more stocks Point State was buying).
The 13F disclosed ownership of about 860,000 shares of Penn National Gaming, Inc (NASDAQ:PENN), a manager of gaming facilities. Casinos and other gaming companies are currently trading at high multiples of their trailing earnings, and Penn National Gaming, Inc (NASDAQ:PENN) is no exception with a trailing P/E of 26. Revenue was up 10% in its most recent quarterly report compared to the fourth quarter of 2011, but net income decreased and we don’t think that the industry in general is a good value. Par Capital Management closed December with 2.5 million shares in its portfolio according to that fund’s own 13F (see more stocks Par likes).
Disclosure: I own no shares of any stocks mentioned in this article.
