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), 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), 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.

Occidental Petroleum ( OXY), which made our list of the most popular energy stocks among hedge funds, was a 590,000-share Chilton holding as of Dec. 31. With trailing and forward P/Es of 15x and 11x, respectively, Occidental is actually valued at a premium to some oil majors. Earnings were down sharply last quarter from the prior year, and while analysts expect the company to recover, we think investors should at least compare the stock with its peers.

Finally, Chilton and his team owned about 440,000 shares of Agrium ( AGU) at the end of the year --though the firm has cut their stake by 51%. Activist fund Jana Partners has been urging Agrium to split its wholesale and retailer businesses -- the company sells agricultural products, including fertilizers and crop-protection products, through both channels -- against resistance from Agrium. The stock currently carries a trailing P/E of 11x. Earnings rose sharply in the company's most recent quarter, but that growth rate is not sustainable, given its much weaker improvements in sales.

-- Written by Matt Doiron

This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.

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