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Were Hedge Funds Right About Dumping NOW Inc (DNOW)?

Before we spend days researching a stock idea we like to take a look at how hedge funds and billionaire investors recently traded that stock. Russell 2000 ETF (IWM) lagged the larger S&P 500 ETF (SPY) by more than 10 percentage points since the end of the third quarter of 2018. This means hedge funds that are allocating a higher percentage of their portfolio to small-cap stocks were probably underperforming the market. However, this also means that as small-cap stocks start to mean revert, these hedge funds will start delivering better returns than the S&P 500 Index funds. In this article, we will take a look at what hedge funds think about NOW Inc (NYSE:DNOW).

Is NOW Inc (NYSE:DNOW) undervalued? Hedge funds are reducing their bets on the stock. The number of bullish hedge fund positions dropped by 3 lately. Our calculations also showed that DNOW isn’t among the 30 most popular stocks among hedge funds (see the video below). DNOW was in 11 hedge funds’ portfolios at the end of June. There were 14 hedge funds in our database with DNOW positions at the end of the previous quarter.
5 Most Popular Stocks Among Hedge Funds
Video: Click the image to 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 market by 40 percentage points since May 2014 through May 30, 2019 (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.

DNOW_oct2019

Unlike former hedge manager, Dr. Steve Sjuggerud, who is convinced Dow will soar past 40000, our long-short investment strategy doesn’t rely on bull markets to deliver double digit returns. We only rely on hedge fund buy/sell signals. Let’s take a glance at the new hedge fund action encompassing NOW Inc (NYSE:DNOW).

How have hedgies been trading NOW Inc (NYSE:DNOW)?

At Q2’s end, a total of 11 of the hedge funds tracked by Insider Monkey were long this stock, a change of -21% from the previous quarter. The graph below displays the number of hedge funds with bullish position in DNOW over the last 16 quarters. With the smart money’s positions undergoing their usual ebb and flow, there exists a few key hedge fund managers who were adding to their holdings considerably (or already accumulated large positions).

Jeffrey Bronchick - Cove Street Capital

The largest stake in NOW Inc (NYSE:DNOW) was held by D E Shaw, which reported holding $32.7 million worth of stock at the end of March. It was followed by Millennium Management with a $27.7 million position. Other investors bullish on the company included Cove Street Capital, Renaissance Technologies, and Tudor Investment Corp.

Seeing as NOW Inc (NYSE:DNOW) has witnessed bearish sentiment from the aggregate hedge fund industry, it’s easy to see that there was a specific group of hedge funds who sold off their full holdings by the end of the second quarter. At the top of the heap, Peter Rathjens, Bruce Clarke and John Campbell’s Arrowstreet Capital dropped the biggest position of all the hedgies followed by Insider Monkey, valued at about $2.6 million in stock. Benjamin A. Smith’s fund, Laurion Capital Management, also said goodbye to its stock, about $0.4 million worth. These bearish behaviors are intriguing to say the least, as aggregate hedge fund interest dropped by 3 funds by the end of the second quarter.

Let’s now take a look at hedge fund activity in other stocks similar to NOW Inc (NYSE:DNOW). These stocks are Electronics For Imaging, Inc. (NASDAQ:EFII), Coherus Biosciences Inc (NASDAQ:CHRS), Madrigal Pharmaceuticals, Inc. (NASDAQ:MDGL), and Aircastle Limited (NYSE:AYR). All of these stocks’ market caps are closest to DNOW’s market cap.

Ticker No of HFs with positions Total Value of HF Positions (x1000) Change in HF Position
EFII 15 152934 0
CHRS 27 263266 0
MDGL 12 360275 -7
AYR 12 77868 0
Average 16.5 213586 -1.75

View table here if you experience formatting issues.

As you can see these stocks had an average of 16.5 hedge funds with bullish positions and the average amount invested in these stocks was $214 million. That figure was $88 million in DNOW’s case. Coherus Biosciences Inc (NASDAQ:CHRS) is the most popular stock in this table. On the other hand Madrigal Pharmaceuticals, Inc. (NASDAQ:MDGL) is the least popular one with only 12 bullish hedge fund positions. Compared to these stocks NOW Inc (NYSE:DNOW) is even less popular than MDGL. Hedge funds dodged a bullet by taking a bearish stance towards DNOW. Our calculations showed that the top 20 most popular hedge fund stocks returned 24.4% in 2019 through September 30th and outperformed the S&P 500 ETF (SPY) by 4 percentage points. Unfortunately DNOW wasn’t nearly as popular as these 20 stocks (hedge fund sentiment was very bearish); DNOW investors were disappointed as the stock returned -22.3% during the third quarter and underperformed the market. If you are interested in investing in large cap stocks with huge upside potential, you should check out the top 20 most popular stocks among hedge funds as many of these stocks already outperformed the market so far in 2019.

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

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