5 High-Potential Picks From This Hedgie’s $600 Million Equity Portfolio

Meena is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

In the world of hedge funds there are thousands of money managers. Many members of the financial press speciously shrug off this group, but a select group of hedgies is actually worth retail investors’ time. At Insider Monkey, we’ve found that by focusing on the best stock picks of the best hedge fund managers, it is possible to beat the market by a significant margin.

Our small-cap strategy outpaced the market by 18% a year for more than a decade, and since we began sharing this with the public last fall our picks have beaten the S&P 500 index by 22.5 percentage points in only 5.5 months (learn how you can capitalize on these dominant strategies here).

With that in mind, it’s also important to do a fund-by-fund analysis of hedgies’ favorite stock picks, and the latest round of fourth quarter 13F filings from the SEC lets us do just that. Let’s take a look at Robert Jaffe’s Force Capital, which is a U.S.-centric long/short equity fund that specializes in deep fundamental research, predominantly on middle-market companies in financial, consumer and industrial sectors (here’s Jaffe’s full equity portfolio).

Sears Hometown and Outlet Stores (NASDAQ: SHOS) is Jaffe’s No. 1 stock pick and was a new position for the hedge fund manager last quarter. Since spinning off from Sears Holdings in mid-October, shares of the appliance and hardware-focused retailer have returned nearly 50%. In the typical spin-off fashion, Sears Hometown and Outlet was undervalued from launch, and despite their rapid appreciation, they still trade at a 13% discount to their industry’s average book valuation. While there’s nothing here for income-seeking investors, the multiples are splendid, as are Jaffe’s company in SHOS. At the end of Q4, Murray Stahl, Steven Cohen and Chuck Royce were also long.

First Industrial Realty Trust and iStar Financial sit at the No.’s 2 and 3 spots in Jaffe and Force’s equity portfolio, and interestingly the hedgie was downsizing his stake in both REITs by about 20% last quarter. While it’s impossible to know just what merited this selling—it could have simply been profit taking—it’s worth pointing out that each company has had a significant 2013. Since the start of the year, First Industrial has gained 13.5% while iStar is up 23.9%, and both trade relatively cheaply at the moment.

At 1.4 times its book value, First Industrial is trading at about a 40% discount to peer averages, placing it 4th lowest out of the 13-stock industrial REIT industry. Even more interestingly, iStar trades below parity with its own book value per share, and at 0.6x, it’s in the 5th lowest percentile of the entire financial sector. If pressed to choose one, we’d go with iStar due to its extensive efforts to diversify its asset portfolio post-recession, and Wall Street predicts a double-digit upside is possible (in percentage terms) from current levels.

Cracker Barrel Old Country Store (NASDAQ: CBRL) sits at No. 4 on this list. Jaffe increased the size of his position in the restaurant operator by more than 60% last quarter, marking the second straight quarter he’s upped his stake. Other prominent hedge fund managers like Joel Greenblatt and Glenn Russell Dubin established new positions in Cracker Barrel in Q4; Greenblatt’s presence indicates that a strong value play is present. CBRL shares do, in fact, trade at a mere 12.6 times forward earnings, and its sales valuation is a whopping 40% below parity. Since the start of the year, Cracker Barrel’s stock price has already gained almost 5%, and a dividend yield of 3% is the proverbial icing on the cake.

Ritchie Bros. Auctioneers (NYSE: RBA), lastly, rounds out Jaffe and Force’s top five. The hedge fund increased its position in the industrial auctioneering company by 19% last quarter, and he is joined by top-tier names like Israel Englander and Ken Griffin in this stock. Wall Street’s average price target on Ritchie Bros. is almost identical with its current trading price, but there’s still reason to believe in this momentum play. The sell-side predicts EPS growth to hit 20% next year and 15% annually through at least 2017. At a price-to-earnings multiple a bit less than 30x, shares are still about 20% below their industry’s average.

With results like these, it’s always important to pay attention to the smartest of the smart money, and Robert Jaffe’s Force Capital definitely fits the bill.

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 recommends Cracker Barrel Old Country Store and Ritchie Bros. Auctioneers (USA). 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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