Value Investor Barry Rosenstein’s Small-Cap Picks

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We track 13F filings from hedge funds and other notable investors as part of our work developing investing strategies; for example, we have found that the most popular small cap stocks (defined as those with market caps between $1 billion and $5 billion) among hedge funds generate an average excess return of 18 percentage points per year. Large institutional investors and the financial media do not pay as much attention to stocks in this valuation range, and as a result we think that they are more likely to be mispriced. Read on for our thoughts on five small cap stocks which Barry Rosenstein’s hedge fund JANA Partners owned at the end of December (or see the full list of stocks the fund reported owning):

JANA initiated a position of 6.1 million shares in Copart (NASDAQ: CPRT) during the fourth quarter of 2012. Copart is a $4.2 billion market cap online auctioneer and marketer of vehicles. While the company’s revenue was up significantly in its most recent quarter compared to the same period in the previous fiscal year, net income actually shrunk 2%. In addition, at the current valuation Copart trades at 23 times trailing earnings, and so we think that it’s best to avoid the stock unless the company begins to convert sales growth into earnings.

Rosenstein and his team increased their stake in Rockwood Holdings (NYSE: ROC), a specialty chemicals company. Many chemicals companies are dependent on broader economic activity, and Rockwood is no exception, with the stock’s beta coming in at 2.5. Earnings have not been looking good here as well--they were down 66% in the fourth quarter of 2012 versus a year earlier, though revenue was up slightly.  However, the current valuation of 13 times trailing earnings means that the company does not need to generate much growth. Analyst expectations seem to be for very little, if any, earnings growth over the next couple years.

The fund reported ownership of 1.9 million shares of Visteon (NYSE: VC) as of the beginning of January. Visteon is an auto parts company providing climate and interior components. As with chemicals, auto demand is tied to macro factors, and as a result the beta is high here, at 2.3. Visteon’s forward P/E is low at 11, but many other auto-related companies, including the domestic automakers, are as cheap or even cheaper on that basis. In addition, business slipped last year compared to 2011, and even though earnings were up in percentage terms the stock price seems to already have large future improvements priced in. Billionaire Steve Cohen’s SAC Capital Advisors had 2.5 million shares in its portfolio, according to its own 13F (find Cohen's favorite stocks).

JANA bought 2.4 million shares of Ryman Hospitality Properties (NYSE: RHP) between October and December after not having owned any shares according to its previous filing. The real estate investment trust owns and operates Gaylord branded hotels and convention centers, as well as several Nashville attractions. As a REIT, Ryman is required to distribute a large share of its cash to shareholders in order to preserve its favorable tax status, and as at many such companies this results in a high dividend yield, of 4.5% judging by recent dividend levels and current prices. We would note, however, that a sizable share of the market is bearish, with 26% of the float held short.

Teekay (NYSE: TK) rounds out our list of Rosenstein’s small cap picks, as the filing disclosed a position of 1.3 million shares. The company transports petroleum products such as crude oil and natural gas, and also deserves mention for a considerable dividend yield of 3.7%. We are a bit concerned about the valuation here, however; at a market capitalization of $2.4 billion, the stock is valued at 36 times forward earnings estimates. Cash flow multiples aren’t much better, with the enterprise value being 10.5x trailing twelve month EBITDA.

Income investors could certainly consider Ryman, although we would advise them not to concentrate their portfolio too much on real estate investment trusts. From a value perspective, we actually don’t like a lot of these companies and wonder if Teekay is a short candidate. Rockwood and Visteon (assuming that the company hits its earnings targets) have at least some value potential, but we don’t think those businesses are particularly attractive compared to their peers and other companies exposed to similar factors.

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 recommends Copart. The Motley Fool owns shares of Rockwood Holdings and Ryman Hospitality Properties . 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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