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

Is Discover Financial Services (NYSE:DFS) a good stock to buy 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 have 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.

Discover Financial Services (NYSE:DFS) has seen an increase in support from the world’s most elite money managers lately. DFS was in 39 hedge funds’ portfolios at the end of the second quarter of 2019. There were 36 hedge funds in our database with DFS positions at the end of the previous quarter. Our calculations also showed that DFS isn’t among the 30 most popular stocks among hedge funds (see the video below).
5 Most Popular Stocks Among Hedge Funds
Video: Click the image to watch our video about the top 5 most popular hedge fund stocks.

So, why do we pay attention to hedge fund sentiment before making any investment decisions? 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. Even if you aren’t comfortable with shorting stocks, you should at least avoid initiating long positions in our short portfolio.

DFS_oct2019

Unlike some fund managers who are betting on Dow reaching 40000 in a year, 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 analyze the latest hedge fund action regarding Discover Financial Services (NYSE:DFS).

How are hedge funds trading Discover Financial Services (NYSE:DFS)?

Heading into the third quarter of 2019, a total of 39 of the hedge funds tracked by Insider Monkey held long positions in this stock, a change of 8% from one quarter earlier. Below, you can check out the change in hedge fund sentiment towards DFS over the last 16 quarters. With hedge funds’ sentiment swirling, there exists a few notable hedge fund managers who were upping their holdings substantially (or already accumulated large positions).

TUDOR INVESTMENT CORP

The largest stake in Discover Financial Services (NYSE:DFS) was held by Diamond Hill Capital, which reported holding $313.6 million worth of stock at the end of March. It was followed by AQR Capital Management with a $161.4 million position. Other investors bullish on the company included Arrowstreet Capital, GLG Partners, and Millennium Management.

As one would reasonably expect, specific money managers have jumped into Discover Financial Services (NYSE:DFS) headfirst. Holocene Advisors, managed by Brandon Haley, assembled the largest position in Discover Financial Services (NYSE:DFS). Holocene Advisors had $26.7 million invested in the company at the end of the quarter. Renaissance Technologies also made a $12.1 million investment in the stock during the quarter. The other funds with brand new DFS positions are Matthew Tewksbury’s Stevens Capital Management, Gregg Moskowitz’s Interval Partners, and Paul Tudor Jones’s Tudor Investment Corp.

Let’s now take a look at hedge fund activity in other stocks similar to Discover Financial Services (NYSE:DFS). We will take a look at Waste Connections, Inc. (NYSE:WCN), Verisign, Inc. (NASDAQ:VRSN), Baker Hughes, a GE company (NYSE:BHGE), and MPLX LP (NYSE:MPLX). This group of stocks’ market valuations are closest to DFS’s market valuation.

Ticker No of HFs with positions Total Value of HF Positions (x1000) Change in HF Position
WCN 26 429678 0
VRSN 32 6013225 1
BHGE 18 337104 -5
MPLX 11 511213 1
Average 21.75 1822805 -0.75

View table here if you experience formatting issues.

As you can see these stocks had an average of 21.75 hedge funds with bullish positions and the average amount invested in these stocks was $1823 million. That figure was $936 million in DFS’s case. Verisign, Inc. (NASDAQ:VRSN) is the most popular stock in this table. On the other hand MPLX LP (NYSE:MPLX) is the least popular one with only 11 bullish hedge fund positions. Compared to these stocks Discover Financial Services (NYSE:DFS) is more popular among hedge funds. Our calculations showed that top 20 most popular stocks among hedge funds returned 24.4% in 2019 through September 30th and outperformed the S&P 500 ETF (SPY) by 4 percentage points. Hedge funds were also right about betting on DFS, though not to the same extent, as the stock returned 5.1% during the third quarter and outperformed the market as well.

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