FPA Queens Road's Strategic Pivot: From InterDigital to Undervalued AI Gems

In the ever-evolving landscape of small-cap value investing, the FPA Queens Road Small Cap Value Fund has made a bold strategic shift in 2025, pivoting from high-growth tech plays like InterDigital (IDCC) to undervalued AI stocks with stronger near-term momentum. This move, outlined in the fund's Q1 2025 investor letter, reflects a calculated bet on the AI sector's explosive potential while sidestepping overvalued or less-convincing opportunities.

The Rationale for Divesting InterDigital

InterDigital, a leader in wireless and AI technologies, has delivered impressive returns: a 11.91% one-month gain and a 95.19% surge over the past 52 weeks as of May 21, 2025. Despite its technical strengths and exposure to AI, the fund has opted to divest. Why? The answer lies in valuation and conviction.

While IDCC's stock trades at a market cap of $5.563 billion, it is not among the 30 Most Popular Stocks Among Hedge Funds, and its ownership by hedge funds increased only marginally from 23 to 34 portfolios in Q4 2024. The fund's managers argue that IDCC's valuation no longer reflects the aggressive growth potential of the AI sector. In a volatile market environment—exacerbated by President Trump's April 2025 tariff announcements—the fund prioritizes assets with clearer catalysts and more attractive entry points.

The Case for Undervalued AI Stocks

The fund's reallocation strategy centers on AI stocks trading at less than 5 times earnings—comparable to NVIDIA's growth but at a fraction of the price. This approach targets companies with strong fundamentals, low P/E ratios, and near-term momentum, positioning them as “sleepers” in the AI boom.

1. Yiren Digital (YRD): The AI-Driven Financial Services Powerhouse

• P/E Ratio: 2.8
• Market Cap: $0.5B
• Momentum Signal: Regulatory approval for its proprietary “Zhiyu Large Model” in April 2025 has unlocked commercialization in China's insurance sector.
  Yiren's AI capabilities are already enhancing underwriting and risk assessment, yet its valuation remains a stark discount to peers. This mispricing could correct as the market recognizes its role in AI-powered financial services.

2. Consensus Cloud Solutions (CCSI): Healthcare Data's AI Revolution

• P/E Ratio: 5.0
• Market Cap: $0.4B
• Momentum Signal: Its AI tool “Clarity” extracts unstructured data from healthcare records, a critical need in an industry grappling with data overload.
  With healthcare AI adoption accelerating, CCSI's low valuation and niche expertise make it a compelling buy for investors seeking undervalued growth.

3. DXC Technology (DXC): Enterprise AI's Undervalued Workhorse

• P/E Ratio: 6.8
• Market Cap: $2.6B
• Momentum Signal: DXC's AI-driven digital transformation services for Fortune 500 clients align with the global push for enterprise automation.
  Despite its size and client base, DXC trades at a discount to its AI-focused peers, offering a balance of stability and growth.

Strategic Advantages and Risks

The fund's Q1 2025 performance (-2.51%) outpaced the Russell 2000 Value Index (-7.74%), underscoring the efficacy of its AI-focused reallocation. By targeting undervalued AI stocks, the fund mitigates the risk of overpaying for hype while capitalizing on near-term catalysts like regulatory approvals (e.g., Yiren's Zhiyu model) and sector-specific demand (e.g., healthcare AI).

However, risks persist. Regulatory shifts, particularly in China and the U.S., could disrupt AI commercialization. Additionally, value traps—stocks that appear cheap but lack sustainable growth—remain a concern. Investors must scrutinize each AI stock's revenue drivers and competitive moats.

Investment Advice: Balancing Value and Momentum

For investors seeking to mirror the fund's strategy, a diversified approach is key. Prioritize AI stocks with:
1. Strong EBITDA margins to ensure profitability amid macroeconomic headwinds.
2. Clear revenue catalysts (e.g., new product launches, regulatory approvals).
3. Low P/E ratios relative to growth peers, signaling undervaluation.

Consider a core-satellite portfolio: allocate 60% to value-oriented AI stocks like YRD and CCSI, and 40% to higher-growth names with proven AI infrastructure (e.g., NVIDIA). This balances the fund's cautious value tilt with the AI sector's high-growth potential.

Conclusion

FPA Queens Road's pivot from IDCC to undervalued AI stocks exemplifies a disciplined, forward-looking strategy. By leveraging low valuations and near-term momentum, the fund positions itself to outperform in a market increasingly driven by AI innovation. For individual investors, this approach offers a roadmap to capitalize on the AI revolution without overpaying for speculative hype. As the sector matures, the winners will be those who combine rigorous valuation analysis with a clear-eyed view of AI's transformative potential.