Billionaire Michael Price’s Small-Cap Picks

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The most popular small cap stocks (which we define as those with market capitalizations between $1 billion and $5 billion) among hedge funds outperform the S&P 500 by an average of 18 percentage points per year, according to our analysis of 13F filings. This makes sense to us since most small cap stocks are ignored by large institutional investors such as mutual funds, as it is hard for them to take a large liquid position; as a result, small caps are more likely to be undervalued or overvalued. So we think that it can be useful to review a manager’s top picks and treat them as a list of initial ideas that can then be researched further. Here are billionaire Michael Price’s MFP Investors’ top small cap picks as of the end of December (or see the full list of stocks the fund reported owning).

Price had 1.8 million shares of Symetra Financial (NYSE: SYA) in his portfolio at the end of 2012. Symetra is a $1.9 billion market cap life insurance company; that valuation represents a large discount to the book value of Symetra’s equity, with a P/B ratio of 0.5, and so the stock has a substantial potential upside just from rising to reflect internal asset valuations. Earnings multiples are low as well, with both the trailing and forward P/E multiples coming in at 9. While the stock is cheap on both grounds, we would note that sales and net income have been down, so the company should be researched carefully before actually deciding whether or not it is a value stock.

The fund slightly increased the size of its position in marine energy services company Gulfmark Offshore (NYSE: GLF) to a total of about 620,000 shares. Business has not been good recently at Gulfmark, with revenue down (falling 5% in its last quarterly report compared to Q4 2011) and earnings being low enough to result in fairly low earnings compared to the stock’s valuation (the trailing P/E comes out to 51). Wall Street analysts expect Gulfmark to recover in 2014, and as a result the forward earnings multiple is 10, but we’d hesitate to take their optimism at face value given recent performance.

Kaiser Aluminum (NASDAQ: KALU) was another of Price’s small cap picks, with the filing disclosing ownership of a little over 300,000 shares. In the fourth quarter of 2012, earnings rose 49% versus a year earlier, but revenue actually slipped slightly; with both the trailing and forward earnings multiples in the low teens, that seems like an important factor to investigate. This is because Kaiser needs at least some earnings growth over the next several years to justify its current valuation, but even moderate improvements could make it a good value; while net income has been up nicely, that is unlikely to be sustainable if sales are stagnant.

MFP owned 800,000 shares of J.C. Penney (NYSE: JCP) at the beginning of October, and apparently kept that stake constant through Q4. The stock price is down 60% in the last year as the retailer’s turnaround strategy has failed for the time being, which has resulted in the departure of CEO Ron Johnson. Billionaire Bill Ackman’s Pershing Square has been a major shareholder, with over 39 million shares as of the end of 2012 (find Ackman's favorite stocks). J.C. Penney is not expected to be profitable this year or next year, and 37% of the float is held short as many believe that it has further to fall. We think that the stock is too dependent on what has so far been an elusive recovery to be considered a value play.

The 13F showed the fund with 810,000 shares of Barnes & Noble (NYSE: BKS) at the beginning of 2013. Barnes & Noble has done well year to date as the market looks for some sort of breakup of the retail and Nook businesses to create shareholder value, though the most recent data shows that over 30% of the float is held short, as neither of those business segments is considered that attractive. Barnes & Noble is expected to report net losses in this fiscal year (which ends at the end of April) and in the next one. As a result the company seems too speculative to be worth buying right now.

The retailers listed here look too turnaround-dependent for us to consider them as good buys at this time. Gulfmark, with the considerable discrepancy between trailing earnings and forward estimates, is also better avoided. In the case of Kaiser and Symetra, there is at least something of a value prospect, but with each company revenue has been declining recently, and so we would need to assure ourselves that net income will be stable to moderately increasing going forward.

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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