Were Hedge Funds Right Betting On These Tech Stocks in Q4?

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The U.S. economic growth in the fourth quarter of fiscal year 2015 was bolstered by the tightening labor market and depressed crude oil prices, both of which started to propel higher consumer spending. Most importantly, the third-quarter correction in U.S. equities has created buying opportunities in strong companies, some of which will be discussed later on in this article. The Federal Reserve finally kicked off the tightening cycle, so one might expect fundamentally strong companies to outperform in the upcoming years. Leaving the fourth-quarter summary aside, this article mainly focuses on discussing the fourth-quarter performance of the five most popular stocks among the hedge funds tracked by Insider Monkey. Four of these five favored stocks greatly outperformed the broader market during the fourth quarter (the S&P 500 Index returned 6.45% during that period), whereas the only laggard stock among these five picks surprisingly failed to retain investor interest.

Why do we track 13F filings of hedge funds and other institutional investors? The reason is simple: we analyze the equity portfolios of these funds and identify trading opportunities. However, we mainly focus on their small-cap picks, which, as we have determined, can provide the highest returns. According to our backtests covering the period between 1999 and 2012, the 15 most popular stocks among hedge funds generated around 81 basis points of alpha per month on average (see the details here).

#5 Microsoft Corporation (NASDAQ:MSFT)

Hedge Funds with Long Positions (as of September 30): 113

Fourth-quarter Return: 26.16%

The number of hedge funds from our database with positions in Microsoft Corporation (NASDAQ:MSFT) climbed to 113 from 107 during the third quarter, so the hedge fund industry made the right bet when it comes to Microsoft. The technology company that focuses on building platforms and productivity services in the cloud space has seen its shares gain 12% over the past year, after advancing by slightly more than 26% in the fourth quarter. The sustained growth in cloud computing represented the key catalyst of Microsoft’s stock performance and growth in 2015.

One of the investors bullish on Microsoft is Barry Rosenstein’s JANA Partners. In his third-quarter investor letter, Rosenstein said that Microsoft has several possibilities to increase its EPS and free cash flow per share over the next 12-24 months. Microsoft’s operating margins have been declining and closed fiscal 2015 at 30%, versus 39% four years earlier.

“In dollar terms, MSFT spends $32 billion on operating expenses, $10 billion more than Apple, Inc. (AAPL) with less than half the sales of Apple, more than Alphabet, Inc (GOOGL), which is famously profligate, and more than Oracle Corp. (ORCL), Intel Corp (INTC) and International Business Machines Corp. (IBM). We think there is plenty of room to drive profitability and believe that management can continue to beat on the opex line, as they have now for seven of the last eight quarters,” Rosenstein said.

The investor is also betting on Microsoft’s capital return and expects the company to keep increasing its dividend and maintain a large buyback program.

“[…] MSFT is undergoing a business model transformation that we believe is advantageous for customers and for owners. The transition of office from a license selling model to an annual subscription service will double the lifetime value or a license customer and has the potential to improve the user experience as updates are continuously provided in a cloud service model. Speaking of the cloud, we believe that the relevant scale enterprise cloud players have narrowed to two leaders – AWS and Azure.”

Rosenstein also said that Satya Nadella is doing a good job at making product decisions capable of improving “the culture and the image of Microsoft”.

“Putting it all together, we see an asymmetric risk/reward profile in a large cap leader undergoing a significant transformation. This is precisely the type of value + catalyst situation we are looking to put capital behind in today’s environment,” the investor concluded.

Just recently, BMO Capital Markets initiated coverage on the stock with an ‘Outperform’ rating and a price target of $64, which yields an upside potential of at least 21%. The firm’s analysts believe that Microsoft Azure is set to grow by at least 55% over the next three-year period, and might account for approximately 5% of Microsoft’s top-line figure by fiscal year 2018. Jeffrey Ubben’s ValueAct Capital is the largest equity holder in Microsoft Corporation (NASDAQ:MSFT) within our database, holding 75.27 million shares as of September 30. JANA Partners disclosed a smaller position, containing 7.70 million shares of the company.

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