Hedge Fund Manager David Abrams’ Top Small-Cap Picks

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Hedge funds generate a significant portion of their alpha in their small-cap investments, primarily because there is less publicly available information about these stocks. At Insider Monkey, we've empirically tested this phenomenon, and according to our own analysis, investing in hedge funds’ top small-cap picks has generated an alpha of about 120 basis points 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 small-cap strategy).

Using our database of 13F filings from the SEC, let’s take a look at one hedge fund in particular: David Abrams’ Abrams Capital Management. We’ll give a brief run-through of the fund’s small-cap holdings (see Abrams Capital Management’s full 13F portfolio). Each has a market capitalization between $1 billion and $5 billion, which is the same criterion used in our market-beating strategy.

Lamar Advertising (NASDAQ: LAMR) is Abrams’ No. 1 stock holding overall, worth over 28% of his 13F portfolio at the end of the last filing period. It’s not often that we see a fund with nearly $1 billion in 13F assets under management have such a large percentage of its portfolio invested in one particular small-cap. So, the obvious question is: Why is Abrams so bullish on Lamar?

Well, for starters, the billboard advertising company’s industry-level outlook is promising, as it slowly upgrades its ad portfolio digitally. Due to the fact that digital billboards offer ad space to multiple customers, revenue per board is inherently increased. Now, the Street expects this bullish trend to positively impact Lamar’s bottom line, as the average analyst is projecting EPS growth in excess of 100% this year.

Now, it’s worth mentioning that the stock currently trades at a PEG above 2.0, but if it can post Q4 earnings above the 10-cent consensus, there’s more upside to be had. Lamar reports next quarter’s financials on Feb. 27; we’ll be watching this date closely.

Next up we have Arbitron (NYSE: ARB), sitting at fourth in Abrams’ portfolio, good for his second favorite small-cap. Arbitron provides market research to players in all aspects of the media world, from mobile advertisers to television networks. The company’s most notable services are audience measurement, local and regional qualitative customer data, and various software programs.

One of the company’s key growth drivers is its ability to install “annual price escalators” in its clients’ contracts. Keeping this in mind, the sell-side expects Arbitron’s earnings growth to accelerate notably over the next five years, forecasting an annual expansion of 13-14%. Over the past half-decade, EPS growth averaged just 2.9% a year. While the value isn’t outstanding—a PEG of 1.7 and a forward P/E of 18.5x—growth-oriented investors can be satisfied with Arbitron.

Abrams’ third favorite small-cap stock is Wesco Aircraft Holdings (NYSE: WAIR). As its name suggests, Wesco Aircraft Holdings is a holding company for Wesco Aircraft Hardware. The company provides services related to supply chain management to many clients throughout the global aerospace industry. The holding company has beaten Wall Street’s earnings expectations in two consecutive quarters but still trades at a paltry forward multiple below 10x. There’s not a lot of analyst coverage on WAIR—Imperial Capital and Robert W. Baird are the most prominent—but on average, the consensus is that the stock has a 20% upside from current levels ($13.15).

Joining Abrams in Wesco Aircraft last filing period were a few notable hedge fund managers, including Chuck Royce, Howard Guberman and Ken Griffin. Griffin is the manager of mega-fund Citadel Investment Group (see all of Ken Griffin’s top stock picks here).

Last but certainly not least, Abrams’ fourth and final small-cap pick is Clear Channel Outdoor Holdings (NYSE: CCO). Clear Channel operates in the same bullish ad space as Lamar and CBS Outdoor, a division of CBS Corporation (NYSE: CBS).

While it’s tempting to consider Clear Channel on equal ground compared to Lamar—at least in terms of exposure to a shift to digital billboard ads—there’s one other growth driver at play here. Clear Channel Airports, which operates within CCO, has quite the opportunity with ClearVision. ClearVision is what the company’s calling its novel in-airport TV technology.

The Louis Armstrong New Orleans International Airport will be the first location outfitted with ClearVision, but it’s worth noting that if the program is successful, investors can expect other airports to follow. The sell-side expects earnings growth to average 8-9% over the next five years, above the likes of Lamar, but below CBS. Still, at a mere 4.7 times its cash (Lamar trades at 100.5x and CBS is at 25.4x), we can see why it is an integral part of David Abrams’ portfolio.

This article is written by Jake Mann 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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