Billionaire Steve Cohen’s Most Promising Stock Picks

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Small-cap and mid-cap stocks don’t get as much attention from bankers, third-party analysts, and the media, which often leaves them less efficiently priced than large- and mega-caps. Hedge funds sometimes take advantage of this by dedicating their research teams to work on these lower valuation stocks as well, and so often earn substantial alpha from their investments. Retail investors can use smaller-cap stocks that hedge funds reported owning as a list of suggestions, which may result in outperformance; we’ve determined 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 shared the stock picks of this strategy. Since then this strategy returned 14.3% (between September and December) vs. 2.1% for the S&P 500 index (learn more about our hedge fund small cap strategy). Investors can’t buy every single small-cap stock that any hedge fund likes and so it probably works best to review each pick in search of those with the best potential. Here are five stocks that billionaire Steve Cohen’s SAC Capital Advisors reported owning on its most recent 13F (see the full list of Cohen's stock picks) with market capitalizations between $1 billion and $5 billion:

Branded and generic drug manufacturer Endo Health Solutions (NASDAQ: ENDP) was SAC’s top pick in that range with the fund reporting a position of 4.6 million shares. The stock price is down 27% in the last year, but sell-side analysts are confident that the company will deliver high earnings in 2013. D.E. Shaw, a large hedge fund managed by David Shaw, also had a large position in Endo at the end of the third quarter.

SAC also liked Superior Energy Services (NYSE: SPN), with its position of 6.2 million shares at the end of September being much larger than three months earlier. Superior is an oilfield equipment and services company which most notably provides services related to offshore drilling. It currently trades at 10 times earnings, whether we consider trailing results or consensus for this year, and its five-year PEG ratio is 0.5, as analysts expect considerable earnings growth over the next several years. We think it has at least some upside potential and could be a good value stock.

The fund cut its stake in Ariad Pharmaceuticals (NASDAQ: ARIA) but still reported 4.9 million shares of the $3.2 billion market cap cancer drug developer in its portfolio. As a development stage company Ariad is expected to be unprofitable when its 2012 numbers are fully in, as well as for the current year, but the stock is up 36% since a year ago as investors have become more optimistic about its prospects. However, we think that we would avoid it for now. Billionaire Dan Loeb’s Third Point also had a position in the stock, though he was selling as well.

Visteon Corporation (NYSE: VC), a provider of auto components including climate and electronics systems, was another midcap stock in SAC’s portfolio as the fund owned 2.6 million shares. A number of insiders have been buying Visteon (see a history of insider purchases at Visteon), which can signal confidence in the company. The P/E based on 2013 earnings estimates is 15, though the stock is highly exposed to the broader economy (the beta is 2.4), and revenue and earnings have been down. The consensus insider buying makes it worth a look, but we would need quite a bit of convincing considering Visteon’s recent financial performance.

Cohen and his team had about 4 million shares of NCR Corporation (NYSE: NCR), a provider of ATMs and other self-service kiosks. Greenlight Capital, managed by billionaire David Einhorn, had NCR as one of its ten largest single-stock holdings at the end of the third quarter. This is another stock where Wall Street analysts see considerable upside: The current price is 10 times expected earnings for this year and the five-year PEG ratio is 0.8. We think that value investors should be considering this stock as well.

This article is written by Matt Doiron and edited by Meena Krishnamsetty. They don't own shares in any of the stocks mentioned in this article. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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