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Bargain-Basement Picks From a Hedge Fund

In mid-February, the last of the fourth-quarter disclosures rolled in for hedge funds and other notable investors. We have found that, despite the delay in many of these 13-F filings, it is still possible to use them to develop profitable investment strategies. The most popular small-cap stocks among hedge funds, for example, outperform the S&P 500 by an average of 18 percentage points per year. If you look at 13-Fs as sources of ideas from top market players, you can proceed to refine these ideas further or do more research on interesting names.

With that in mind, let's take a look at the cheap stocks held by billionaire Richard Chilton's Chilton Investment -- that is, stocks priced at no more than 16x their trailing and forward price-to-earnings ratios.

As of Dec. 31, Chilton owned more than seven million shares of Corning (GLW - Get Report), making the stock its seventh-largest holding overall. Corning, which provides materials for display screens and other purposes, saw revenue rise 14% year over year last quarter, though earnings were down sharply. Judging by the trailing P/E of 11x, the market is expecting a stable to declining profit in the medium term. Wall Street analysts are only mildly optimistic, with consensus 2014 estimates implying a forward earnings multiple of 10x. While the stock is cheap, we would want to see its business stabilize before we'd consider it on a value basis.

This article originally appeared on March 18, 2013, on RealMoney. To read more content like this + see inside Jim Cramer's $3 Million portfolio for FREE Click Here NOW.

Auto-parts retailer AutoZone (AZO), with $14 billion in market capitalization, was Chilton's eighth-largest position at about 230,000 shares. Given its business focus, AutoZone has little exposure to the broader economy, so the stock's beta is 0.2. The company's financial performance has been somewhat stable, with only limited growth on both top and bottom lines, although the shares trade at 16x trailing earnings. We think the company would need higher growth in order for the stock to be undervalued at that price point.

Chilton also added a small number of shares to its position in Avago Technologies (AVGO - Get Report), an $8.8 billion-market-cap semiconductor-device designer based in Singapore. The stock, Chilton's ninth-largest holding, has dipped a bit in the last year against a rising market, and revenue growth has been limited. This is not a positive development, considering that the trailing earnings multiple is 16x. The sell side expects considerable earnings growth over the next couple of years, translating into a forward P/E of 13x. Still, we would prefer to avoid Avago until it has shown that it can grow earnings and hit analyst targets.

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