Hedge Funds Were Right to Ditch These Sinking Stocks, Part 2

We at Insider Monkey like to follow the smart money’s collective sentiment, as our research has shown that we can improve our chances of outperforming the market by doing so. Because the best and brightest work for them, notable collective movement in stock ownership among elite funds will often foreshadow big moves up or down for those stocks. In the second-part of this two-part article, we take a closer look at five stocks whose shares have fallen substantially since the smart money tracked by Insider Monkey began heading for the exits. Those stocks are Valeant Pharmaceuticals Intl Inc (NYSE:VRX), Sunedison Inc (NYSE:SUNE), Williams Companies Inc (NYSE:WMB), Cheniere Energy, Inc. (NYSEMKT:LNG), and Hertz Global Holdings Inc (NYSE:HTZ).

Most investors ignore hedge funds’ moves because as a group their average net returns trailed the market since 2008 by a large margin. Unfortunately, most investors don’t realize that hedge funds are hedged and they also charge an arm and a leg, so they are likely to underperform the market in a bull market. We ignore their short positions and by imitating hedge funds’ stock picks independently, we don’t have to pay them a dime. Our research have shown that hedge funds’ long stock picks generate strong risk adjusted returns. For instance the 15 most popular small-cap stocks outperformed the S&P 500 Index by an average of 95 basis points per month in our back-tests spanning the 1999-2012 period. We have been tracking the performance of these stocks in real-time since the end of August 2012. After all, things change and we need to verify that back-test results aren’t just a statistical fluke. We weren’t proven wrong. These 15 stocks managed to return 102% over the last 38 months and outperformed the S&P 500 Index by 53 percentage points (see the details here).

#5 Hertz Global Holdings Inc (NYSE:HTZ)

 – Number of Hedge Fund Holders (as of September 30): 54
– Total Value of Hedge Fund Holdings (as of September 30): $3.48 billion
– Hedge Fund Holdings as Percent of Float (as of September 30): 45.40%

From our database of around 730 funds, the number of elite investors long Hertz Global Holdings Inc (NYSE:HTZ) fell by 13 between the end of the second and third quarters. Shares of the rental car company declined by just 7.7% in the same time frame, which wouldn’t justify the huge flight of capital, but have since declined by another 14% in the fourth quarter. Investors are less optimistic on the stock because of the strong dollar and weak macro-economic conditions. Hertz’s earnings results haven’t been as good as expected either, with the company missing profit expectations by $0.03 per share and revenue estimates by $90 million for its third quarter. Given Uber’s success, investors hope Hertz’s management can do more in the mobile space to make renting a vehicle easier and more convenient.

#4 Cheniere Energy, Inc. (NYSEMKT:LNG)

 – Number of Hedge Fund Holders (as of September 30): 62
– Total Value of Hedge Fund Holdings (as of September 30): $7.12 billion
– Hedge Fund Holdings as Percent of Float (as of September 30): 62.30%

With natural gas at Henry Hub trading for previously unthinkable prices, Cheniere Energy, Inc. (NYSEMKT:LNG) shares retreated by 30.3% in the third quarter while the total number of elite funds long the stock fell to 62 from 76. Shares have continued to slide in the fourth quarter, down by another 14%. Some bearish investors such as Jim Chanos don’t think Cheniere Energy will be the cash cow that the market expects. Other bearish investors are selling because China’s economy isn’t as strong as it was. If China doesn’t consume as much LNG as analysts predict over the next decade, Cheniere bulls will need to lower their cash flow expectations. Among those bulls is Carl Icahn‘s Icahn Capital LP, with a holding of 28.55 million shares as of the latest 13F reporting period.

#3 Williams Companies Inc (NYSE:WMB)

 – Number of Hedge Fund Holders (as of September 30): 73
– Total Value of Hedge Fund Holdings (as of September 30): $6.05 billion
– Hedge Fund Holdings as Percent of Float (as of September 30): 21.90%

Along with that of other midstream energy companies, shares of Williams Companies Inc (NYSE:WMB) fell substantially in the third quarter. Williams’ stock dropped 34.9% from June 30 to September 30, while the total number of elite funds long the stock fell from 86 to 73, and shares have dipped by another 28% in the fourth quarter. In late September, Energy Transfer Equity LP (NYSE:ETE) agreed to merge with Williams Companies Inc (NYSE:WMB) in a deal that is expected to yield $2 billion in annual EBITDA synergies by 2020. Under the terms of the merger, Williams Companies’ shareholders are entitled to 1.8716 Energy Transfer Equity LP (NYSE:ETE) shares for each share of Williams. Williams Companies’ shareholders can also elect to get cash, but on a prorated basis of $6.05 billion. Once the $6.05 billion of cash is paid out, Williams’ shareholders can only receive Energy Transfer Equity LP shares. Because the deal has a limited cash component, the deal is sinking in value because of ETE’s own declining shares. Stephen Mandel‘s Lone Pine Capital owned 17.68 million shares of Williams Companies at the end of the third quarter.

#2 Sunedison Inc (NYSE:SUNE)

 – Number of Hedge Fund Holders (as of September 30): 73
– Total Value of Hedge Fund Holdings (as of September 30): $1.06 billion
– Hedge Fund Holdings as Percent of Float (as of September 30): 46.80%

A net of 20 elite funds sold out of Sunedison Inc (NYSE:SUNE) in the third quarter, as shares of the beleaguered solar developer dropped by 76% during that time as liquidity concerns began to mount. Shares have continued to crumble in the fourth quarter, down by another 42%. Despite the flight of elite funds from the stock, SunEdison is still a hedge fund favorite, with 73 funds owning around 46.80% of the company’s float as of September 30. SunEdison and the solar industry could receive some good news in the near future if Congress extends favorable renewable energy policies in exchange for lifting the crude oil export ban. David Einhorn‘s Greenlight Capital owned 18.61 million shares of SunEdison at the end of September.

#1 Valeant Pharmaceuticals Intl Inc (NYSE:VRX)

 – Number of Hedge Fund Holders (as of September 30): 88
– Total Value of Hedge Fund Holdings (as of September 30): $17.73 billion
– Hedge Fund Holdings as Percent of Float (as of September 30): 29.10%

The number of elite funds long Valeant Pharmaceuticals Intl Inc (NYSE:VRX) fell to 88 from 98 quarter-over-quarter, as shares of the former high flier came crashing down to earth because of concerns over drug price regulation and later, over Valeant’s exact relationship with Philidor. Because of the concerns, shares of Valeant are now off by 34.97% year-to-date, including a 47% fall in the fourth quarter. To the company’s credit, Valeant shares have stabilized in recent weeks and Valeant uber-bull Bill Ackman‘s Pershing Square recently increased its stake to 9.9% of the company’s float, from the previous 5.7% held on September 30. If it doesn’t have any additional skeletons in its closet, Valeant should soon trade in the triple digits again.

Disclosure: None