Capital Growth Management’s Small-Cap Picks

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

Our analysis of quarterly 13F filings from hundreds of hedge funds and other notable investors such as Ken Heebner’s Capital Growth Management shows that the most popular small cap stocks among the group we track outperform the S&P 500 by an average of 18 percentage points per year. We think that this is because large institutional investors pay less attention to small-cap stocks, making them less efficiently priced and therefore making it more likely for research teams to uncover an undervalued (or overvalued) stock. We also like to check out filings from individual managers to see if any of their free small cap investing ideas look interesting. Read on for our quick take on Capital Growth Management’s five largest small cap holdings (defining small caps as those with a market capitalization between $1 billion and $5 billion) as of the end of March, or see the full list of the asset manager's stock picks.

Leading our list is $4.6 billion market cap homebuilder NVR (NYSE: NVR); Heebner bought almost 100,000 shares of the stock during the first quarter of 2013. With the housing market doing well so far this year, NVR experienced a 28% increase in revenue last quarter compared to the first quarter of 2012 with earnings rising at an even higher rate. The market price already incorporates expectations of some future growth, with a trailing P/E of 24, though recent growth has been high enough that investors willing to take on housing-related risks might be interested.

Capital Growth Management reported a position of 3.8 million shares in RLJ Lodging Trust (NYSE: RLJ), a real estate investment trust focused on hotels. Real estate investment trusts receive favorable tax treatment conditional on distributing a large share of their taxable income to shareholders, which can often result in high yields. Currently RLJ’s dividend yield is 3.5%, though the company only became publicly traded about two years ago and therefore has a limited history of paying dividends. In addition, we’d advise income investors against focusing too much of their portfolio on REITs.

Heebner and his team disclosed ownership of almost 700,000 shares of Jones Lang LaSalle (NYSE: JLL) after not having owned any shares at the beginning of the year. Jones Lang LaSalle provides property management and investment management services to owners of real estate. While the company’s revenue was up in the first quarter of 2013 versus a year earlier, earnings were down, and with a trailing P/E of 19 we would avoid it. Generation Investment Management, a fund co-managed by David Blood and Al Gore, had 1.9 million shares in its portfolio according to its own 13F (find Generation's favorite stocks).

Sunstone Hotel Investors (NYSE: SHO), another hotel-focused REIT that primarily owns upscale hotels, was another of Capital Growth Management’s small cap picks. This shows that the fund is quite interested in hotels and in real estate related companies in general--we can see a number of larger-cap stocks related to the same thesis in its portfolio as well. Currently common shareholders of Sunstone are not receiving dividends, but we’d note that some industry peers have been increasing their payments and we suppose the dividend could be reinstated if conditions are strong.

According to the 13F, the asset manager added another hotel REIT, Strategic Hotels & Resorts (NYSE: BEE), to its portfolio between January and March. Strategic Hotels & Resorts owns properties across the U.S. and in a few locations in Europe. As with Sunstone, the company suspended its common dividends during the financial crisis. The company’s most recent 10-Q showed a net loss for the quarter with cash flow from operations being barely positive, and while it’s also possible that the company could start paying dividends again we think that we’d avoid it for now.

We’d rather not speculate on these two hotel REITs reinstating their dividends, and while RLJ does currently offer an attractive yield it might be better to look for blue-chip companies in the 3.5% yield range. Jones Lang LaSalle also looks to be of questionable value, given its recent financial performance. We’re interested in the homebuilders, although investors should be aware of the risks in the industry. We also aren’t sure that NVR will prove to be a better value than its peers. 

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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 Jones Lang LaSalle. The Motley Fool owns shares of Jones Lang LaSalle. 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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