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Were Hedge Funds Right About Piling Into Discover Financial Services (DFS)?

We know that hedge funds generate strong, risk-adjusted returns over the long run, which is why imitating the picks that they are collectively bullish on can be a profitable strategy for retail investors. With billions of dollars in assets, professional investors have to conduct complex analyses, spend many resources and use tools that are not always available for the general crowd. This doesn’t mean that they don’t have occasional colossal losses; they do. However, it is still a good idea to keep an eye on hedge fund activity. With this in mind, let’s examine the smart money sentiment towards Discover Financial Services (NYSE:DFS) and determine whether hedge funds skillfully traded this stock.

Is Discover Financial Services (NYSE:DFS) a buy right now? Money managers were becoming hopeful. The number of long hedge fund bets improved by 1 in recent months. 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.

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 101% since March 2017 and outperformed the S&P 500 ETFs by more than 58 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 Rogers Ariel Investments

John Rogers of Ariel Investments

At Insider Monkey we scour multiple sources to uncover the next great investment idea. For example, this trader claims to score lucrative profits by utilizing a “weekend trading strategy”, so we look into his strategy’s picks. Federal Reserve has been creating trillions of dollars electronically to keep the interest rates near zero. We believe this will lead to inflation and boost gold prices. So, we are checking out this junior gold mining stock. We read hedge fund investor letters and listen to stock pitches at hedge fund conferences. We recently recommended several stocks partly inspired by legendary Bill Miller’s investor letter. Our best call in 2020 was shorting the market when the S&P 500 was trading at 3150 in February after realizing the coronavirus pandemic’s significance before most investors. Keeping this in mind we’re going to take a look at the key hedge fund action surrounding Discover Financial Services (NYSE:DFS).

What does smart money think about Discover Financial Services (NYSE:DFS)?

At Q1’s end, a total of 40 of the hedge funds tracked by Insider Monkey were long this stock, a change of 3% from the previous quarter. By comparison, 36 hedge funds held shares or bullish call options in DFS a year ago. With hedge funds’ sentiment swirling, there exists an “upper tier” of noteworthy hedge fund managers who were adding to their holdings meaningfully (or already accumulated large positions).

According to publicly available hedge fund and institutional investor holdings data compiled by Insider Monkey, Cliff Asness’s AQR Capital Management has the most valuable position in Discover Financial Services (NYSE:DFS), worth close to $125.1 million, corresponding to 0.2% of its total 13F portfolio. The second largest stake is held by Citadel Investment Group, managed by Ken Griffin, which holds a $105.5 million position; less than 0.1%% of its 13F portfolio is allocated to the stock. Some other hedge funds and institutional investors with similar optimism comprise Peter Rathjens, Bruce Clarke and John Campbell’s Arrowstreet Capital, Steven Richman’s East Side Capital (RR Partners) and Israel Englander’s Millennium Management. 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, designating 4.98 percent of its 13F equity portfolio to DFS.

Consequently, specific money managers were breaking ground themselves. 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 made a $12.2 million investment in the stock 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 go over 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 are similar to 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 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 DFS as the stock returned 42% 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.

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