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Should You Buy NeoPhotonics Corp (NPTN)?

Nina Todic

As we already know from media reports and hedge fund investor letters, many hedge funds lost money in October, blaming macroeconomic conditions and unpredictable events that hit several sectors, with healthcare among them. Nevertheless, most investors decided to stick to their bullish theses and their long-term focus allows us to profit from the recent declines. In particular, let’s take a look at what hedge funds think about NeoPhotonics Corp (NYSE:NPTN) in this article.

Hedge fund interest in NeoPhotonics Corp (NYSE:NPTN) shares was flat at the end of last quarter. This is usually a negative indicator. At the end of this article we will also compare NPTN to other stocks including American Software, Inc. (NASDAQ:AMSWA), Digimarc Corp (NASDAQ:DMRC), and Jernigan Capital Inc (NYSE:JCAP) to get a better sense of its popularity.

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 18 percentage points since May 2014 through December 3, 2018 (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.

Chuck Royce

Let's review the recent hedge fund action surrounding NeoPhotonics Corp (NYSE:NPTN).

How are hedge funds trading NeoPhotonics Corp (NYSE:NPTN)?

Heading into the fourth quarter of 2018, a total of 10 of the hedge funds tracked by Insider Monkey held long positions in this stock, representing no change from the second quarter of 2018. By comparison, 13 hedge funds held shares or bullish call options in NPTN heading into this year. With hedge funds' positions undergoing their usual ebb and flow, there exists an "upper tier" of key hedge fund managers who were upping their holdings meaningfully (or already accumulated large positions).

No of Hedge Funds with NPTN Positions

More specifically, Royce & Associates was the largest shareholder of NeoPhotonics Corp (NYSE:NPTN), with a stake worth $20.3 million reported as of the end of September. Trailing Royce & Associates was Masters Capital Management, which amassed a stake valued at $16.6 million. Millennium Management, Citadel Investment Group, and Boardman Bay Capital Management were also very fond of the stock, giving the stock large weights in their portfolios.

We view hedge fund activity in the stock unfavorable, but in this case there was only a single hedge fund selling its entire position: Levin Capital Strategies. One hedge fund selling its entire position doesn't always imply a bearish intent. Theoretically a hedge fund may decide to sell a promising position in order to invest the proceeds in a more promising idea. However, we don't think this is the case in this case because only one of the 800+ hedge funds tracked by Insider Monkey identified as a viable investment and initiated a position in the stock (that fund was D E Shaw).

Let's now review hedge fund activity in other stocks similar to NeoPhotonics Corp (NYSE:NPTN). We will take a look at American Software, Inc. (NASDAQ:AMSWA), Digimarc Corp (NASDAQ:DMRC), Jernigan Capital Inc (NYSE:JCAP), and Legacy Reserves Inc. (NASDAQ:LGCY). This group of stocks' market values match NPTN's market value.

[table] Ticker, No of HFs with positions, Total Value of HF Positions (x1000), Change in HF Position AMSWA,6,29991,-2 DMRC,2,25242,-2 JCAP,10,41696,0 LGCY,6,12823,1 Average,6,27438,-0.75 [/table]

View table here if you experience formatting issues.

As you can see these stocks had an average of 6 hedge funds with bullish positions and the average amount invested in these stocks was $27 million. That figure was $60 million in NPTN's case. Jernigan Capital Inc (NYSE:JCAP) is the most popular stock in this table. On the other hand Digimarc Corp (NASDAQ:DMRC) is the least popular one with only 2 bullish hedge fund positions. NeoPhotonics Corp (NYSE:NPTN) is not the most popular stock in this group but hedge fund interest is still above average. This is a slightly positive signal but we'd rather spend our time researching stocks that hedge funds are piling on. In this regard JCAP might be a better candidate to consider a long position.

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

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