There are many different financial indicators that ardent investors must follow, but one of the most important is hedge fund activity. While it’s tempting to think of the smart money’s decisions as insignificant, consider the following: our empirical research shows that individuals who mimic hedge fund activity can beat the market by double-digits year in and year out (see the details of our market-beating strategy here).
Generally speaking, one of the economy’s most bullish macro trends is a continued recovery in housing, and we’re going to take a look at which homebuilders are in hedge funds’ favor. Using our database of the latest 13F filings with the SEC, we can determine how money managers are trading this particular industry.
Of the more than 400 hedge funds we track at Insider Monkey, Lennar Corporation (NYSE:LEN) had the highest level of interest, with 45 funds invested at the end of the last filing period. Lennar doesn’t pay a stellar dividend—about a 0.4% yield—but it has appreciated more than 86% over the past year. One of the homebuilder’s key advantages is its ability to use specialized deals to attain top-tier acreage at attractive prices. The sell-side expects earnings growth of 10-11% a year over the next half-decade, and at a PEG near 1.4, Lennar’s prospects are fairly valued. According to our data, one of the most bullish hedge funds invested in Lennar is Ken Griffin’s Citadel Investment Group (see Ken Griffin’s favorite stock picks here).
Second on our list is PulteGroup, Inc. (NYSE:PHM), with 32 hedge funds invested. Pulte’s footprint in the housing market is about 25% larger than Lennar’s, and shares of the company have been a better investment—returning 153%—over the past twelve months. At first glance, Pulte’s forward P/E (16.7x) and extremely bullish year-ahead earnings expectations of $1.44 a share look supremely attractive, especially considering it’s forecasted to finish FY2012 with a 67-cent EPS. Over the longer term, however, Pulte’s growth prospects trade at a multiple of 4.5; typically any figure above 2.0 signals an overvaluation. With a five-year expected EPS growth rate nearly identical to that of Lennar, Pulte doesn’t look like a great value at the moment.
Next up is Toll Brothers Inc (NYSE:TOL), which had five fewer bullish hedgies than Pulte at the end of the latest filing period. Wall Street’s forecasts for Toll Brothers are more than twice as optimistic as those placed on Pulte or Lennar; analysts expect EPS growth to average 22.4% a year through 2017. At a PEG near 0.5, it’s clear that investors are severely discounting these prospects, and quite frankly, are unfairly treating Toll Brothers as a low double-digit growth stock when it clearly has much more potential.
How do we know this?