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Hedge Funds Are Nibbling On Discover Financial Services (DFS)

Before we spend countless hours researching a company, we like to analyze what insiders, hedge funds and billionaire investors think of the stock first. This is a necessary first step in our investment process because our research has shown that the elite investors’ consensus returns have been exceptional. In the following paragraphs, we find out what the billionaire investors and hedge funds think of Discover Financial Services (NYSE:DFS).

Is Discover Financial Services (NYSE:DFS) ready to rally soon? Hedge funds are becoming hopeful. The number of long hedge fund bets advanced by 1 recently. Our calculations also showed that DFS 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). DFS was in 40 hedge funds’ portfolios at the end of March. There were 39 hedge funds in our database with DFS holdings at the end of the previous quarter.

Video: Watch our video about the top 5 most popular hedge fund stocks.

Hedge funds’ reputation as shrewd investors has been tarnished in the last decade as their hedged returns couldn’t keep up with the unhedged returns of the market indices. 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 51 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.

Dmitry Balyasny of Balyasny Asset Managemnet

Dmitry Balyasny of Balyasny Asset Management

At Insider Monkey we leave no stone unturned when looking for the next great investment idea. For example, we believe electric vehicles and energy storage are set to become giant markets, and we want to take advantage of the declining lithium prices amid the COVID-19 pandemic. So we are checking out investment opportunities like this one. We interview hedge fund managers and ask them about their best ideas. If you want to find out the best healthcare stock to buy right now, you can watch our latest hedge fund manager interview here. We read hedge fund investor letters and listen to stock pitches at hedge fund conferences. Our best call in 2020 was shorting the market when the S&P 500 was trading at 3150 after realizing the coronavirus pandemic’s significance before most investors. Keeping this in mind we’re going to go over the recent hedge fund action surrounding Discover Financial Services (NYSE:DFS).

Hedge fund activity in Discover Financial Services (NYSE:DFS)

At Q1’s end, a total of 40 of the hedge funds tracked by Insider Monkey were bullish on this stock, a change of 3% from one quarter earlier. Below, you can check out the change in hedge fund sentiment towards DFS over the last 18 quarters. So, let’s examine which hedge funds were among the top holders of the stock and which hedge funds were making big moves.

Among these funds, AQR Capital Management held the most valuable stake in Discover Financial Services (NYSE:DFS), which was worth $125.1 million at the end of the third quarter. On the second spot was Citadel Investment Group which amassed $105.5 million worth of shares. Arrowstreet Capital, East Side Capital (RR Partners), and Millennium Management were also very fond of the stock, becoming one of the largest hedge fund holders of the company. 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 5.31% of its 13F portfolio. Meru Capital is also relatively very bullish on the stock, dishing out 4.98 percent of its 13F equity portfolio to DFS.

As aggregate interest increased, specific money managers were leading the bulls’ herd. Prana Capital Management, managed by Peter Seuss, created the largest position in Discover Financial Services (NYSE:DFS). Prana Capital Management had $12.8 million invested in the company at the end of the quarter. Dmitry Balyasny’s Balyasny Asset Management also initiated a $12.2 million position during the quarter. The following funds were also among the new DFS investors: John W. Rogers’s Ariel Investments, Paul Marshall and Ian Wace’s Marshall Wace LLP, and Phill Gross and Robert Atchinson’s Adage Capital Management.

Let’s now take a look at hedge fund activity in other stocks similar to Discover Financial Services (NYSE:DFS). These stocks are International Flavors & Fragrances Inc (NYSE:IFF), Broadridge Financial Solutions, Inc. (NYSE:BR), Teledyne Technologies Incorporated (NYSE:TDY), and Nucor Corporation (NYSE:NUE). This group of stocks’ market valuations match DFS’s market valuation.

Ticker No of HFs with positions Total Value of HF Positions (x1000) Change in HF Position
IFF 28 163049 0
BR 29 307241 -6
TDY 21 384671 -3
NUE 26 95527 0
Average 26 237622 -2.25

View table here if you experience formatting issues.

As you can see these stocks had an average of 26 hedge funds with bullish positions and the average amount invested in these stocks was $238 million. That figure was $467 million in DFS’s case. Broadridge Financial Solutions, Inc. (NYSE:BR) is the most popular stock in this table. On the other hand Teledyne Technologies Incorporated (NYSE:TDY) is the least popular one with only 21 bullish hedge fund positions. Compared to these stocks Discover Financial Services (NYSE:DFS) 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 8.3% in 2020 through the end of May but still managed to beat the market by 13.2 percentage points. Hedge funds were also right about betting on DFS as the stock returned 34.7% so far in Q2 (through the end of May) 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.

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