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

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.

#4 Amazon.com Inc. (NASDAQ:AMZN)

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

Fourth-quarter Return: 32.04%

Shares of Amazon.com Inc. (NASDAQ:AMZN) gained 32% in the last quarter of fiscal year 2015, and are up 109% over the past one year. A total of 113 hedge funds tracked by Insider Monkey were invested in the company at the end of the third quarter, as compared with 103 funds a quarter earlier. It is believed that Amazon is planning an aggressive expansion of its Amazon Web Services (AWS)’s data center footprint, which could put some weight on profit margins in the near-term. Nonetheless, the fast-growing top-line results of Amazon’s North American retail segment and AWS segment will most likely overshadow the transitory impacts on earnings.

Meanwhile, Amazon’s fourth-quarter guidance shows that the company anticipates its net sales to be in the range of $33.50 billion-to-$36.75 billion, which denotes an increase of 14%-to-25% year-on-year. Andreas Halvorsen’s Viking Global upped its positon in Amazon.com Inc. (NASDAQ:AMZN) by 33% during the July-to-September period to 3.02 million shares.

#3 Facebook Inc. (NASDAQ:FB)

Hedge Funds with Long Positions (as of September 30): 128

Fourth-quarter Return: 16.42%

Facebook Inc. (NASDAQ:FB) lost some of its charm among the hedge funds tracked by our team, but its shares advanced by 16% in the fourth quarter of 2015. Numerous analysts and financial hubs anticipate that the social networking company will generate strong revenue growth from video ads and higher monetization efforts of Instagram in the upcoming quarters.

In early November, Rosenblatt Securities reiterated its ‘Buy’ rating on the stock and increased its price target to $125 from $115, claiming that Facebook represents its top stock pick across the Internet, media and entertainment space for 2016. Facebook is set to release its fourth-quarter and full year 2015 financial results after the market close on January 27, thus revealing the fruits of the management’s monetization efforts. In the meantime, Rosenblatt Securities anticipates Instagram to generate roughly $1 billion in global advertising revenues in 2016. Stephen Mandel’s Lone Pine Capital reported ownership of 10.70 million shares in Facebook Inc. (NASDAQ:FB) through its 13F for the third quarter.

#2 Alphabet Inc. (NASDAQ:GOOGL)

Hedge Funds with Long Positions (as of September 30): 129

Fourth-quarter Return (Class A shares): 21.87%

Alphabet Inc. (NASDAQ:GOOGL) has received more attention from the hedge funds monitored by our team, as the number of smart money investors owning the tech giant’s Class A shares grew to 129 from 115 during the third quarter. Alphabet’s Class A stock gained nearly 22% in the fourth quarter, while its Class C shares advanced by almost 25% during the same period.

The company’s core advertising business has achieved double-digit growth over the past several quarters and may keep doing so in the upcoming future, thanks to the strong growth in mobile search. Its Google websites revenue for the nine months that ended September 30 totaled $37.42 billion, up from $32.66 billion reported for the same period of the prior year. However, it remains to see whether Alphabet’s search segment is set to slide toward single-digit growth or continue growing at double-digit rates.

Andreas Halvorsen’s Viking Global represents a prominent investor in Alphabet Inc. (NASDAQ:GOOGL), holding 2.53 million Class A shares and 1.12 million Class C shares as of September 30. In his third-quarter investor letter, Halvorsen said:

“Among long positions, Alphabet was the biggest winner, contributing 1.2% to both funds. Our core thesis revolves around the company’s transition from desktop to mobile. In our opinion, prevailing concerns around this transition are misguided and mobile represents a tremendous revenue opportunity.”

The investor also believes that Alphabet will be capable to achieve significant revenue growth as the advertising is shifting towards search and YouTube from more traditional media. The company’s reorganization will allow the company to focus on operating efficiencies and “streamlining capital allocation.”

“We find the current valuation compelling, especially in light of the company’s growing net cash position, and the likelihood that strong revenue growth combined with improved cost control will result in a higher price-to-earnings multiple,” Halvorsen concluded.

#1 Apple Inc. (NASDAQ:AAPL)

Hedge Funds with Long Positions (as of September 30): 133

Fourth-quarter Return: -4.10%

Apple Inc. (NASDAQ:AAPL) was the second most popular stock pick among the hedge funds tracked by Insider Monkey at the end of the third quarter. The iPhone maker had a slightly disappointing fourth-quarter in terms of stock performance, as its shares slid 4% during the three-month period. The increased worries about Apple’s high reliance on iPhone sales and supersaturation in the smartphone market has pushed the stock below $100.

It is true that the company’s iPhone sales will not grow forever, so investors’ increased concerns seem to be legitimate. Nonetheless, it is highly unlikely that Apple will focus on its iPhone sales endlessly, so one should anticipate new innovations from the highly-successful company. One should also keep in mind that Apple is currently building its “spaceship” campus in Cupertino, so it is quite clear that this company will aim high in the upcoming years. Meanwhile, the upcoming release of the iPhone 7 will surely shed some light on the direction of Apple’s iPhone sales for the next couple of years. Billionaire Carl Icahn of Icahn Capital LP holds a 52.76 million-share position in Apple Inc. (NASDAQ:AAPL) as of September 30.

Disclosure: None