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Hedge Funds Dropped The Ball On Zscaler, Inc. (ZS)

We hate to say this but, we told you so. On February 27th we published an article with the title Recession is Imminent: We Need A Travel Ban NOW and predicted a US recession when the S&P 500 Index was trading at the 3150 level. We also told you to short the market and buy long-term Treasury bonds. Our article also called for a total international travel ban. While we were warning you, President Trump minimized the threat and failed to act promptly. As a result of his inaction, we will now experience a deeper recession (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. Keeping this in mind, let’s take a look at whether Zscaler, Inc. (NASDAQ:ZS) is a good investment right now. We at Insider Monkey like to examine what billionaires and hedge funds think of a company before spending days of research on it. Given their 2 and 20 payment structure, hedge funds have more incentives and resources than the average investor. The funds have access to expert networks and get tips from industry insiders. They also employ numerous Ivy League graduates and MBAs. Like everyone else, hedge funds perform miserably at times, but their consensus picks have historically outperformed the market after risk adjustments.

Is Zscaler, Inc. (NASDAQ:ZS) a sound stock to buy now? Money managers are getting less bullish. The number of long hedge fund bets retreated by 3 in recent months. Our calculations also showed that ZS isn’t among the 30 most popular stocks among hedge funds (click for Q4 rankings and see the video at the end of this article for Q3 rankings). ZS was in 18 hedge funds’ portfolios at the end of December. There were 21 hedge funds in our database with ZS holdings at the end of the previous quarter.

In the financial world there are a large number of tools investors have at their disposal to grade stocks. A pair of the most under-the-radar tools are hedge fund and insider trading indicators. We have shown that, historically, those who follow the top picks of the best fund managers can outperform the broader indices by a solid amount. Insider Monkey’s monthly stock picks returned 72.9% since March 2017 and outperformed the S&P 500 ETFs by more than 41 percentage points. Our short strategy outperformed the S&P 500 short ETFs by 20 percentage points annually (see the details here). That’s why we believe hedge fund sentiment is a useful indicator that investors should pay attention to.

John Overdeck of Two Sigma

John Overdeck of Two Sigma Advisors

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. With all of this in mind let’s take a gander at the key hedge fund action regarding Zscaler, Inc. (NASDAQ:ZS).

How are hedge funds trading Zscaler, Inc. (NASDAQ:ZS)?

Heading into the first quarter of 2020, a total of 18 of the hedge funds tracked by Insider Monkey were bullish on this stock, a change of -14% from one quarter earlier. On the other hand, there were a total of 17 hedge funds with a bullish position in ZS a year ago. With hedge funds’ positions undergoing their usual ebb and flow, there exists a select group of notable hedge fund managers who were upping their holdings meaningfully (or already accumulated large positions).

Among these funds, Two Sigma Advisors held the most valuable stake in Zscaler, Inc. (NASDAQ:ZS), which was worth $42.5 million at the end of the third quarter. On the second spot was Citadel Investment Group which amassed $18.9 million worth of shares. Cota Capital, Citadel Investment Group, and ExodusPoint Capital 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 Cota Capital allocated the biggest weight to Zscaler, Inc. (NASDAQ:ZS), around 7.04% of its 13F portfolio. Stony Point Capital is also relatively very bullish on the stock, designating 4.11 percent of its 13F equity portfolio to ZS.

Judging by the fact that Zscaler, Inc. (NASDAQ:ZS) has witnessed falling interest from hedge fund managers, logic holds that there lies a certain “tier” of hedge funds who were dropping their positions entirely heading into Q4. It’s worth mentioning that Josh Donfeld and David Rogers’s Castle Hook Partners dropped the largest investment of all the hedgies followed by Insider Monkey, totaling close to $14.6 million in stock, and Panayotis Takis Sparaggis’s Alkeon Capital Management was right behind this move, as the fund dumped about $11.1 million worth. These bearish behaviors are intriguing to say the least, as total hedge fund interest fell by 3 funds heading into Q4.

Let’s check out hedge fund activity in other stocks – not necessarily in the same industry as Zscaler, Inc. (NASDAQ:ZS) but similarly valued. We will take a look at Kinross Gold Corporation (NYSE:KGC), The Scotts Miracle-Gro Company (NYSE:SMG), BWX Technologies Inc (NYSE:BWXT), and Lincoln Electric Holdings, Inc. (NASDAQ:LECO). This group of stocks’ market valuations are similar to ZS’s market valuation.

Ticker No of HFs with positions Total Value of HF Positions (x1000) Change in HF Position
KGC 25 448750 -3
SMG 31 365213 -3
BWXT 22 81924 -3
LECO 16 245514 -2
Average 23.5 285350 -2.75

View table here if you experience formatting issues.

As you can see these stocks had an average of 23.5 hedge funds with bullish positions and the average amount invested in these stocks was $285 million. That figure was $90 million in ZS’s case. The Scotts Miracle-Gro Company (NYSE:SMG) is the most popular stock in this table. On the other hand Lincoln Electric Holdings, Inc. (NASDAQ:LECO) is the least popular one with only 16 bullish hedge fund positions. Zscaler, Inc. (NASDAQ:ZS) is not the least popular stock in this group but hedge fund interest is still below average. 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 17.4% in 2020 through March 25th but still beat the market by 5.5 percentage points. A small number of hedge funds were also right about betting on ZS as the stock returned 27.2% during the same time period and outperformed the market by an even larger margin.
5 Most Popular Stocks Among Hedge Funds
Video: Click the image to watch our video about the top 5 most popular hedge fund stocks.

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

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