2 New Stock Ideas from a Guy who's Beat Wall Street for 15 Years Running

James Brumley's picture

Monday, May 21, 2012 - 1:25pm

by James Brumley

It's that time of year again, when investment managers are required to disclose their fund's holdings to the SEC, and by extension, to all investors. And for most investment companies and hedge funds, it's a pretty straight-forward process... just make a list of all the stocks you own, and how much of them you own.

If you're Greenlight Capital's David Einhorn, however, it's not quite that simple. With Einhorn's willingness to hold short as well as long positions (not to mention his willingness to speak out about them) in the $7 billion hedge fund, it's a bit of a process to truly figure out what he's thinking, or trading.

On the other hand, considering his fund has returned an average of 21% per year for the past 15 years, sifting through the data is worth the effort.

What Einhorn likes

Of course, closed trades are history and don't offer investors any new specific coattails to ride. The best clues traders can glean from Greenlight's exits last quarter are to look at what he bought.

There were only three new positions added in the first quarter, in addition to only three existing trades that were bolstered.

Einhorn increased his stake in information services firm DST Systems (NYSE: DST) by 39% to a total position of about 1.5 million shares, while the fund's stake in semiconductor maker Marvell Technology Group Ltd (Nasdaq: MRVL) and data storage firm Seagate Technology (Nasdaq: STX) both saw a very modest amount of new money thrown in -- nothing noteworthy on either front.

As for the brand new positions, eyebrows may have been raised, but he may well be on to something good...

The biggest addition was the 1 million-share, $33 million position in online travel booking site Expedia (Nasdaq: EXPE).

In retrospect, it was a brilliant a trade. The stock jumped from $32.63 to $40.30 on April 27th after the company handily topped earnings estimates of $0.16 per share by posting a gain of $0.26. Clearly it was a nice call, but given Einhorn's active nature, odds are decent that he's already aiming to lock in the 25% gain.

The other two new positions are likely to be intact, as they seem to be longer-term ideas. As such, they're the ones investors may want to seriously consider.

The first one is Computer Sciences Corp. (NYSE: CSC). Einhorn bought 2.4 million shares of the $4 billion computer services firm, making his stake worth $61 million. Computer Sciences Corp. is a bit of a leap of faith. The company isn't profitable on a trailing basis, but is expected to swing to a profit -- in spades -- this year. The pros say the outfit is poised to earn $$2.69 per share for the current fiscal year (ending in March of 2013), and earn $3.11 per share next fiscal year, thanks to a recently-announced $1 billion cost-cutting effort. That translates into a forward-looking price-to-earnings (P/E) ratio of only about 8, which is a bargain by almost any standard.

The other newcomer to the Greenlight portfolio is the 561,934 share, $5.6 million position in Roundy's (NYSE: RNDY). Yes, this is the same grocery store that saw its shares take a 20% hit a couple of weeks ago on weak same-store as well as overall sales results. Net earnings cratered, from $0.29 per share a year earlier to $0.06 in the first quarter of this year.

It's an inauspicious start. And besides, what's an aggressive guy like Einhorn want with a grocery store stock anyway? Actually, he's probably doing what all investors should be doing: looking at the bigger picture.

As it turns out, on an operating basis, Roundy's actually earned $0.28 per share last quarter, topping estimates of $0.26. The company also expects its expansion effort to lead to annual revenue growth of 2.5% to 3.0%. That's not a lot, but in the grocery business, where margins are notoriously thin, a little more incremental revenue goes a long way toward the bottom line.

Risks to Consider: While it's possible for all hedge funds, it's especially possible for an actively-traded fund like Greenlight Capital, that by the time you learn about a position, it's actually been exited for weeks.

Action to Take--> While Greenlight Capital added just three new positions and only added to three pre-existing positions, there's actually a lot of potential within that small group.

My top pick among those is Roundy's, with Computer Science Corp. being a close runner-up. While it's not without its challenges, Roundy's didn't deserve the hit it suffered earlier in the month. Investors just can't get past the poor GAAP results yet, even if they're temporary. The forward-looking P/E of less than 7 for the grocer implies there's about 40% upside before it's valued on par with its peers. Computer Science Corp. is also about 40% undervalued, though it could take longer to re-inflate the stock's price, since the value is based on earnings that won't be reported for more than a year. Still, it's a compelling idea, too.

James Brumley does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.