Apple Inc. (NASDAQ:AAPL) versus American International Group Inc (NYSE:AIG). We know how the hedge fund industry at large was playing it last quarter, but it’s worth taking a look at one fund that typically flies under the mainstream media’s radar.
To many investors, hedge funds are slow, underperforming investment vehicles of yesterday. This misperception has spread through the blogosphere, and while it’s tempting to believe it, there are plenty of reasons to pay attention to this space. At Insider Monkey, we track 450 of the world’s most elite hedge fund managers, and our research has shown that historically, their top small-cap picks can generate quite the outperformance. For more than a decade in our back tests, our strategy beat the market by 18% a year, and since we’ve started sharing these picks with the public, it has outpaced the S&P 500 by more than 20% (learn how to use this strategy yourself).
Furthermore, it’s also crucial to look at each of the funds we track individually, and by using the latest round of fourth quarter 13F data from the SEC, we can determine how the hedgies were preparing for 2013. Let’s take a look at one fund in particular: Michael Karsch’s Karsch Capital Management. Here’s his top three stock picks, which comprise about one-fourth of his $1.4 billion equity portfolio.
PPG Industries, Inc. (NYSE:PPG) sits at the No. 1 spot in Karsch’s equity portfolio, and it was a new position for the hedge fund manager last quarter. On the whole, hedge fund interest in the chemical manufacturer that specializes in protective coatings increased by 3% in Q4, with Paul Tudor Jones, Donald Chiboucis and Bruce Kovner also establishing new positions during this period.
Since the start of 2013, shares of PPG have stayed essentially flat, but one potential reason for the smart money’s bullishness may be its spinoff of its commodity chemicals business. This segment of PPG was merged with Georgia Gulf earlier this year, the result of which now trades as Axiall Corp (NYSE:AXLL). PPG shareholders, including Karsch, received a bit more than a 3-for-1 exchange ratio as a result of this deal. Axiall has risen 36.7% year-to-date, while PPG is up just 0.2% over this period.
There’s not much value to be had from PPG at the moment, trading at a whopping 5.1 times book and a PEG in excess of 2.0, but the sell-side does expect earnings to grow by 8-9% over the next five years, almost triple the level of growth it has experienced over the past half-decade. A decent dividend yield of 1.7% adds some income to this momentum play, and it’s worth noting that both of these statistics–yield and forecasted EPS growth–trump Axiall by roughly 2 to 1. It’s easy to see why Karsch is bullish.
American International Group Inc (NYSE:AIG) sits at the No. 2 spot in the hedge fund manager’s equity portfolio, and the insurer was a new position way back in the first quarter of 2012. Generally speaking, Karsch was earlier into AIG than most of his peers.
Interestingly, the company displaced Apple Inc. (NASDAQ:AAPL) as the hedge fund industry’s favorite stock in Q4, which is an unofficial, yet important title to have. Since the start of 2013, shares of AIG have risen by almost 8%, and post-bailout, there’s still a tremendous amount of value here. AIG trades at a measly 0.57 times book, placing it in the cheapest 3% of all publicly traded large-cap companies in the world.
Apple Inc. (NASDAQ:AAPL), meanwhile, is worth mentioning because it also held a small spot in Karsch’s portfolio in Q3, and was cut entirely in Q4. While value investors can make a similar argument for Apple as American International Group Inc (NYSE:AIG), Karsch certainly views these two stocks quite differently, in line with the hedge fund industry’s sentiment at large.
A key difference between these two stocks is relative earnings momentum: American International Group Inc (NYSE:AIG) has it and Apple simply does not. Apple Inc. (NASDAQ:AAPL)’s average annual EPS growth over the past five years came in at just over 62%, while AIG’s was in the red. Over the next half-decade, though, the Street is predicting that AIG’s EPS growth averages 11-12% a year, while Apple’s expectations fall just under 19% annually. Clearly, there are many factors that affect investors’ psyche, but this is an important point to remain aware of. It at least partially explains why Mr. Market seems to view American International Group Inc (NYSE:AIG) as a better investment than Apple Inc. (NASDAQ:AAPL) now, which is a comparison that would have been tough to make a year ago.
QUALCOMM, Inc. (NASDAQ:QCOM), lastly, rounds out Karsch’s top trio, after PPG and AIG. The chipmaker has been a favorite of the hedge fund manager since the third quarter of last year, when Karsch upped his stake by a whopping 586% from Q2 levels.
What about the rest of his peers?
Heading into 2013, Qualcomm had bullish interest from 89 of the 450 funds we track–ninth largest in our entire equity universe. Some of the stock’s biggest supporters include Andreas Halvorsen, Ken Fisher, Stephen Mandel and Jim Simons (see Simons’s full equity portfolio), and Wall Street’s average price target represents a 14-15% upside from current levels. Despite this potential, shares still sport moderately attractive valuation metrics, and trade below 14 times forward earnings.
The reasons that support Michael Karsch’s bullishness on this trio differs depending on the stock, but the one thing that each investment has in common is its support from other key members of the smart money.
Insider Monkey’s small-cap strategy returned 29.2% between September 2012 and February 2013 versus 8.7% for the S&P 500 index. Try it now by clicking the link above.