Coronavirus is probably the #1 concern in investors’ minds right now. It should be. On February 27th we published an article with the title Recession is Imminent: We Need A Travel Ban NOW. We predicted that a US recession is imminent and US stocks will go down by at least 20% in the next 3-6 months. We also told you to short the market ETFs and buy long-term bonds. Investors who agreed with us and replicated these trades are up double digits whereas the market is down double digits. Our article also called for a total international travel ban to prevent the spread of the coronavirus especially from Europe. We were one step ahead of the markets and the president.
In these volatile markets we scrutinize hedge fund filings to get a reading on which direction each stock might be going. Although the masses and most of the financial media blame hedge funds for their exorbitant fee structure and disappointing performance, these investors have proved to have great stock picking abilities over the years (that’s why their assets under management continue to swell). We believe hedge fund sentiment should serve as a crucial tool of an individual investor’s stock selection process, as it may offer great insights of how the brightest minds of the finance industry feel about specific stocks. After all, these people have access to smartest analysts and expensive data/information sources that individual investors can’t match. So should one consider investing in Discover Financial Services (NYSE:DFS)? The smart money sentiment can provide an answer to this question.
Discover Financial Services (NYSE:DFS) shareholders have witnessed a decrease in activity from the world’s largest hedge funds lately. Our calculations also showed that DFS isn’t among the 30 most popular stocks among hedge funds (click for Q4 rankings and see the video below for Q3 rankings).
Video: Click the image to watch our video about the top 5 most popular hedge fund stocks.
So, why do we pay attention to hedge fund sentiment before making any investment decisions? Our research has shown that hedge funds’ small-cap stock picks managed to beat the market by double digits annually between 1999 and 2016, but the margin of outperformance has been declining in recent years. Nevertheless, we were still able to identify in advance a select group of hedge fund holdings that outperformed the S&P 500 ETFs by more than 41 percentage points since March 2017 (see the details here). We were also able to identify in advance a select group of hedge fund holdings that underperformed the market by 10 percentage points annually between 2006 and 2017. Interestingly the margin of underperformance of these stocks has been increasing in recent years. Investors who are long the market and short these stocks would have returned more than 27% annually between 2015 and 2017. We have been tracking and sharing the list of these stocks since February 2017 in our quarterly newsletter. Even if you aren’t comfortable with shorting stocks, you should at least avoid initiating long positions in stocks that are in our short portfolio.
Ric Dillon of Diamond Hill Capital
We leave no stone unturned when looking for the next great investment idea. For example we recently identified a stock that trades 25% below the net cash on its balance sheet. We read hedge fund investor letters and listen to stock pitches at hedge fund conferences, and go through short-term trade recommendations like this one. We even check out the recommendations of services with hard to believe track records. Our best call in 2020 was shorting the market when S&P 500 was trading at 3150 after realizing the coronavirus pandemic’s significance before most investors. Keeping this in mind let’s review the key hedge fund action encompassing Discover Financial Services (NYSE:DFS).
Hedge fund activity in Discover Financial Services (NYSE:DFS)
At the end of the fourth quarter, a total of 39 of the hedge funds tracked by Insider Monkey held long positions in this stock, a change of -5% from the previous quarter. By comparison, 37 hedge funds held shares or bullish call options in DFS a year ago. So, let’s check out which hedge funds were among the top holders of the stock and which hedge funds were making big moves.
The largest stake in Discover Financial Services (NYSE:DFS) was held by Diamond Hill Capital, which reported holding $276.9 million worth of stock at the end of September. It was followed by AQR Capital Management with a $201.6 million position. Other investors bullish on the company included Arrowstreet Capital, GLG Partners, and East Side Capital (RR Partners). In terms of the portfolio weights assigned to each position East Side Capital (RR Partners) allocated the biggest weight to Discover Financial Services (NYSE:DFS), around 7.31% of its 13F portfolio. L2 Asset Management is also relatively very bullish on the stock, designating 2.66 percent of its 13F equity portfolio to DFS.
Due to the fact that Discover Financial Services (NYSE:DFS) has experienced bearish sentiment from the aggregate hedge fund industry, we can see that there exists a select few hedgies who sold off their full holdings in the third quarter. At the top of the heap, Dmitry Balyasny’s Balyasny Asset Management dumped the biggest position of the “upper crust” of funds watched by Insider Monkey, worth an estimated $61.1 million in stock, and Daniel Johnson’s Gillson Capital was right behind this move, as the fund dumped about $7.5 million worth. These bearish behaviors are intriguing to say the least, as aggregate hedge fund interest fell by 2 funds in the third quarter.
Let’s now review hedge fund activity in other stocks – not necessarily in the same industry as Discover Financial Services (NYSE:DFS) but similarly valued. We will take a look at Agilent Technologies Inc. (NYSE:A), Parker-Hannifin Corporation (NYSE:PH), 0, and FirstEnergy Corp. (NYSE:FE). All of these stocks’ market caps are similar to DFS’s market cap.
| Ticker | No of HFs with positions | Total Value of HF Positions (x1000) | Change in HF Position |
|---|---|---|---|
| A | 46 | 2470187 | 5 |
| PH | 39 | 971423 | 11 |
| BKR | 37 | 573421 | 3 |
| FE | 40 | 1419463 | 5 |
| Average | 40.5 | 1358624 | 6 |
View table here if you experience formatting issues.
As you can see these stocks had an average of 40.5 hedge funds with bullish positions and the average amount invested in these stocks was $1359 million. That figure was $831 million in DFS’s case. Agilent Technologies Inc. (NYSE:A) is the most popular stock in this table. On the other hand 0 is the least popular one with only 37 bullish hedge fund positions. Discover Financial Services (NYSE:DFS) is not the least popular stock in this group but hedge fund interest is still below average. This is a slightly negative signal and we’d rather spend our time researching stocks that hedge funds are piling on. Our calculations showed that top 20 most popular stocks among hedge funds returned 41.3% in 2019 and outperformed the S&P 500 ETF (SPY) by 10.1 percentage points. These stocks lost 11.7% in 2020 through March 11th but beat the market by 3.1 percentage points. Unfortunately DFS wasn’t nearly as popular as these 20 stocks (hedge fund sentiment was quite bearish); DFS investors were disappointed as the stock returned -36.9% during the same time period and underperformed the market. If you are interested in investing in large cap stocks with huge upside potential, you should check out the top 20 most popular stocks among hedge funds as most of these stocks already outperformed the market in Q1.
Disclosure: None. This article was originally published at Insider Monkey.
