On May 19, FactSet Research revealed the following two tables on the top stocks hedge funds had purchased and sold during the first quarter. The overall thought process that went in the fund managers’ minds may be hard to decipher for retail investors, but traditional metrics can be used to determine whether investing with the big guys may be worth it.
According to data from Hedge Fund Research, managers on average were down 0.7% in the first quarter of 2016 gauged by the HFRI Fund Weighted Composite Index. That compares with a 0.7% climb for the S&P 500 in the first quarter (Marketwatch).
Most bought stocks
Facebook (FB, Financial) was the most bought stock, in aggregate, by the top 50 hedge funds.
Most sold stocks
Apple (AAPL, Financial) was the most sold stock according to FactSet. Interestingly, Apple was actually the most purchased stock by the hedge funds in the previous quarter.
Numbers
Traditional valuations (price to earnings and price to book).
Starting with the Most Bought list, I figure identifying the respective companies’ valuations would reveal higher valuations.
Yum! Brands (YUM, Financial) demonstrated off the chart P/B valuation at 208, and had to be excluded. Coincidentally, the more the hedge funds spent on purchasing one company, the more valuable it became. SanDisk (SNDK), on the other hand, was not included secondary to recent successful acquisition of Western Digital.
There were no patterns that can be easily recognized here compared to the Most Bought list. Apple seemed to be the cheapest at a P/E of 11 and P/B at 4, while Adobe Systems (ADBE) was the most expensive at a P/E of 61 and P/B of 7. All this while the S&P 500 is at a P/E of 19 and P/B of 3. One can say that Apple is still a bit more expensive than the S&P 500’s P/B valuation.
Profit growth (three-year average versus recent year)
*Green highlights indicate that the company had an above peer number.
In three-year profit averages, Facebook demonstrated outstanding growth (16 times the group average). Accordingly, Facebook, Alphabet (GOOG), Apple, NetEase ADR and Amgen (AMG) exhibited consistent positive profit growth in the past four years.
Free cash flow growth (three-year average versus recent year)
Three-year free cash flow growth revealed that Facebook was a monster compared to its peers in this selection. In addition, Alphabet, Johnson & Johnson, Apple, Broadcom, NetEase, and Amgen demonstrated consistent growth in their free cash flow in the past four years. This, I assume, is relevant especially to investors seeking sustainable dividend and buyback coverage.
Dividend yield and payout ratios (trailing twelve months; TTM)
Accordingly, red highlights in payout-profit section indicated that Air Products & Chemicals (APD) have paid beyond its TTM profits. Meanwhile, payout-FCF revealed that Baxalta (BXLT, Financial) had poor FCF situation at -$81 million TTM, and Eli Lily had paid out more than its FCF to its shareholders.
Green highlights indicated that the company had outperformed its peer average. Overall, NetEase and Apple were the most conservative companies in terms of handing out dividends to its shareholders. Anheuser-Busch Inbev had somewhat similar numbers, but its payout ratio was hovering a bit more than the peer average.
Debt to equity (based on first quarter 2016 filings)
As most conservative investors opt to invest in companies with less than 1 or 0.5 debt to equity ratios, the group gave a debt to equity (D/E) average of 0.50. Numbers calculated from Yum Brands, Wells Fargo (WFC, Financial), McDonald’s (MCD), and Motorola Solutions (MSI) were removed secondary to much higher than average digits. Their D/E were 31, 8, 6, -34, respectively.
Baxalta, EMC Corp, Alphabet, Johnson & Johnson, Pioneer Natural, NetEase, Qualcomm, and Adobe Systems appeared to have more conservative balance sheets among the group.
In summary, Facebook definitely showed the most growth in terms of profits and free cash flow in recent years. As a result, big fund managers have noticed and piled in the company's stock, sending its P/E valuation to the high 70's. Facebook achieved this growth without issuing any debt, therefore providing a health balance sheet. Nonetheless, Facebook had been actively increasing its shares over the years since went public, from 2.3 million in 2011 to 2.8 million shares outstanding in the last 12 months. Facebook won most hedge funds portfolio with 69% of shares outstanding being held by institutional and mutual funds. This series of fortunate events for Facebook had sent its CEO Mark Zuckerberg to the 7th place of World's Richest at $50.7 billion in net worth.
Interestingly, Apple, despite being also commonly owned by most investment funds (at 60%), had been the most sold stock with a low-peer P/E of 11. With several good metrics (stable profit and free cash flow growth, conservative payouts, and a 0.60 debt to equity ratio), one of Warren Buffett (Trades, Portfolio)'s lieutenants picked up 9.81 million shares of the company in the first quarter.
No one can know whether this was a smart move for Berkshire or other recent Apple investors, but with a mean analyst price target of $126 a share, a current price of $95 a share indicates a good 33% margin of safety.
Disclosure: I am long Apple.
Happy investing!
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