Did Hedge Funds Make The Right Call On Advance Auto Parts, Inc. (AAP) ?

At the end of February we announced the arrival of the first US recession since 2009 and we predicted that the market will decline by at least 20% in (see why hell is coming). In these volatile markets we scrutinize hedge fund filings to get a reading on which direction each stock might be going. In this article, we will take a closer look at hedge fund sentiment towards Advance Auto Parts, Inc. (NYSE:AAP) at the end of the first quarter and determine whether the smart money was really smart about this stock.

Advance Auto Parts, Inc. (NYSE:AAP) was in 38 hedge funds’ portfolios at the end of March. AAP investors should be aware of a decrease in hedge fund sentiment in recent months. There were 42 hedge funds in our database with AAP positions at the end of the previous quarter. Our calculations also showed that AAP isn’t among the 30 most popular stocks among hedge funds (click for Q1 rankings and see the video for a quick look at the top 5 stocks).

Video: 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 58 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.

At Insider Monkey we scour multiple sources to uncover the next great investment idea. We read hedge fund investor letters and listen to stock pitches at hedge fund conferences. Hedge fund sentiment towards Tesla reached its all time high at the end of 2019 and Tesla shares more than tripled this year. We are trying to identify other EV revolution winners, so we are checking out this tiny lithium stock. Now we’re going to take a peek at the fresh hedge fund action surrounding Advance Auto Parts, Inc. (NYSE:AAP).

How have hedgies been trading Advance Auto Parts, Inc. (NYSE:AAP)?

At the end of the first quarter, a total of 38 of the hedge funds tracked by Insider Monkey were long this stock, a change of -10% from one quarter earlier. Below, you can check out the change in hedge fund sentiment towards AAP over the last 18 quarters. With hedge funds’ capital changing hands, there exists a select group of noteworthy hedge fund managers who were adding to their stakes meaningfully (or already accumulated large positions).

The largest stake in Advance Auto Parts, Inc. (NYSE:AAP) was held by Melvin Capital Management, which reported holding $309.4 million worth of stock at the end of September. It was followed by Starboard Value LP with a $240.1 million position. Other investors bullish on the company included Diamond Hill Capital, Melvin Capital Management, and Point72 Asset Management. In terms of the portfolio weights assigned to each position Starboard Value LP allocated the biggest weight to Advance Auto Parts, Inc. (NYSE:AAP), around 9.74% of its 13F portfolio. Lionstone Capital Management is also relatively very bullish on the stock, dishing out 4.81 percent of its 13F equity portfolio to AAP.

Because Advance Auto Parts, Inc. (NYSE:AAP) has witnessed bearish sentiment from the entirety of the hedge funds we track, we can see that there exists a select few money managers that decided to sell off their full holdings heading into Q4. It’s worth mentioning that Gregg Moskowitz’s Interval Partners dropped the largest investment of all the hedgies followed by Insider Monkey, comprising an estimated $41.6 million in stock, and Doug Gordon, Jon Hilsabeck and Don Jabro’s Shellback Capital was right behind this move, as the fund dumped about $16.8 million worth. These bearish behaviors are intriguing to say the least, as total hedge fund interest was cut by 4 funds heading into Q4.

Let’s check out hedge fund activity in other stocks similar to Advance Auto Parts, Inc. (NYSE:AAP). We will take a look at Aspen Technology, Inc. (NASDAQ:AZPN), Regency Centers Corp (NASDAQ:REG), AptarGroup, Inc. (NYSE:ATR), and PagSeguro Digital Ltd. (NYSE:PAGS). This group of stocks’ market values are closest to AAP’s market value.

View table here if you experience formatting issues.

As you can see these stocks had an average of 19.5 hedge funds with bullish positions and the average amount invested in these stocks was $388 million. That figure was $840 million in AAP’s case. Aspen Technology, Inc. (NASDAQ:AZPN) is the most popular stock in this table. On the other hand Regency Centers Corp (NASDAQ:REG) is the least popular one with only 18 bullish hedge fund positions. Compared to these stocks Advance Auto Parts, Inc. (NYSE:AAP) is more popular among hedge funds. Our calculations showed that top 10 most popular stocks among hedge funds returned 41.4% in 2019 and outperformed the S&P 500 ETF (SPY) by 10.1 percentage points. These stocks returned 12.3% in 2020 through June 30th but still managed to beat the market by 15.5 percentage points. Hedge funds were also right about betting on AAP as the stock returned 53.2% in Q2 and outperformed the market by an even larger margin. Hedge funds were clearly right about piling into this stock relative to other stocks with similar market capitalizations.

Disclosure: None. This article was originally published at Insider Monkey.