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Lee Ainslie's Hedge Fund Value Picks

Wednesday, 10 Dec 2008 11:34 AM

By Michael Carr

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Little known outside the world of hedge funds, value investor Lee Ainslie has amassed an enviable record at Maverick Capital. Starting with $38 million in 1995, Ainslie now manages more than $10 billion.

Through 2007, he delivered average returns of 17 percent a year to his investors, while the S&P 500 averaged a gain of only 11 percent. Ainslie never had a losing year, although he is down almost 30 percent for the current year through October 2008.

Ainslie started his career working for legendary investor Julian Robertson at Tiger Management. Since "retiring" in 2000, Robertson has earned an average return of 34.5 percent a year in his own account, including a gain of more than 76 percent last year on timely bets that the value of subprime mortgages would decline.

Rather than trading derivatives as Robertson does, Ainslie sticks to stock picking. He manages a traditional hedge fund with a mix of long and short stock positions and generous use of leverage. Individual investors should generally avoid shorting individual stocks due to the high risk, but we can still learn a great deal from Ainslie's stock picking success.

The billionaire looks for strong cash flow and low levels of debt as key measures of value. This serves as the starting point for this week's screen:

  • A price-to-cash flow ratio below the industry average identifies stocks with strong fundamentals at attractive levels of valuation.

  • Debt less than the industry average helps to find companies that are well managed since excessive debt has often led to operating problems in the current business environment.

  • To avoid the value trap of buying stocks declining in price or going nowhere, we will limit the search to stocks that have performed among the top 10 percent of the market over the past six months.

  • Financial companies were excluded because of the continuing uncertainty in that sector.

    From a database of more than 8,800 stocks, only seven made the list:

    Aaron Rents (RNT) is likely to profit from a deteriorating economy. RNT rents a variety of household products, such as plasma televisions, computers, furniture, and appliances. Credit checks usually aren't required, so it can benefit from the tightening credit conditions at other retailers. Bucking the trend of the overall market, the price of RNT is up 30 percent over the past year. At a recent price of 23.65, the company pays a small dividend of 7 cents a share and has increased the dividend an average of 25 percent a year for the past five years.

    AeroCentury (ACY) buys and leases used aircraft to foreign and domestic regional carriers. With a market cap of just $15 million, it can be difficult to buy or sell this stock. Investors should use a limit order to get in and out of small stocks like this. Analysts expect the company to earn almost $3 a share next year, giving ACY a P/E ratio of less than 4 at the recent price of 10.10. Investors enjoy a comfortable margin of safety given the book value of 22.68 per share.

    Casey's General Stores (CASY) operates nearly 1,500 convenience stores and gas stations in the Midwest. Recently trading at 22.18, the stock offers a 1.3 percent dividend yield. Sales growth has been more than four times greater the industry average and its P/E ratio of 13 is in line with the industry average.

    eTelecare Global Solutions (ETEL) provides outsourcing for customer service. ETEL offers tech support, financial advisory services, warranty support, and sales operations to customers such as American Express Company, AOL, AT&T, and Dell. Revenue growth has averaged 74 percent a year for the last five years. Noted value manager Royce Associates owns more than 5 percent of the company and Mario Gabelli has a smaller stake in ETEL. Recent price: 8.75.

    Income Opportunity Realty Investors (IOT) is a thinly traded real estate investment trust. This small company owns one office building, an industrial warehouse, one shopping center, seven apartment properties, and 211 acres of unimproved land, with most of its holdings in Texas. Its return on equity of more than 20 percent is the second highest in the industry. IOT recently traded at a price of 6. The company's most recent earnings reflect various large one-time gains from nonrecurring items, but normalized earnings growth averaged 17 percent a year for the last five years.

    Maxygen, Inc. (MAXY) is a biotechnology company involved in the discovery and development of next-generation protein drugs. Ben Graham would appreciate this stock at a recent price of 7, which means the stock is selling for little more than the cash on hand of 5.73 a share. With no debt, the company has the resources to continue its research, which already has resulted in viable products. Last year, MAXY sold a development program to Bayer Healthcare for $120 million and analysts expect other sales over the next few years.

    Michael Baker (BKR) provides engineering and energy services to public and private sector clients worldwide. Contracts with various branches of the U.S. government accounted for 27 percent of its revenue last year, making BKR well-positioned to benefit from infrastructure projects expected to be proposed by President-elect Barack Obama. Recently trading at 34.11, BKR has a P/E ratio of 8 based on next year's estimated earnings. Billionaire investor Jeffrey Gendell owns almost 8 percent of the company.

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