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Did Hedge Funds Make The Right Call On Houghton Mifflin Harcourt Co (HMHC) ?

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How do you pick the next stock to invest in? One way would be to spend days of research browsing through thousands of publicly traded companies. However, an easier way is to look at the stocks that smart money investors are collectively bullish on. Hedge funds and other institutional investors usually invest large amounts of capital and have to conduct due diligence while choosing their next pick. They don't always get it right, but, on average, their stock picks historically generated strong returns after adjusting for known risk factors. With this in mind, let’s take a look at the recent hedge fund activity surrounding Houghton Mifflin Harcourt Co (NASDAQ:HMHC) and determine whether hedge funds had an edge regarding this stock.

Is Houghton Mifflin Harcourt Co (NASDAQ:HMHC) a bargain? The smart money was reducing their bets on the stock. The number of long hedge fund bets shrunk by 2 lately. Our calculations also showed that HMHC isn't among the 30 most popular stocks among hedge funds (click for Q1 rankings and see the video for a quick look at the top 5 stocks). HMHC was in 20 hedge funds' portfolios at the end of the first quarter of 2020. There were 22 hedge funds in our database with HMHC positions at the end of the previous quarter.

Video: Watch our video about the top 5 most popular hedge fund stocks.

Hedge funds' reputation as shrewd investors has been tarnished in the last decade as their hedged returns couldn't keep up with the unhedged returns of the market indices. 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 S&P 500 ETFs by 58 percentage points since March 2017 (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.

Jay Petschek - Corsair Capital
Jay Petschek - Corsair Capital

At Insider Monkey we scour multiple sources to uncover the next great investment idea. Hedge fund sentiment towards Tesla reached its all time high at the end of 2019 and Tesla shares more than tripled this year. We are trying to identify other EV revolution winners, so we are checking out this under-the-radar lithium stock. We go through lists like the 10 most profitable companies in the world to pick the best large-cap stocks to buy. Even though we recommend positions in only a tiny fraction of the companies we analyze, we check out as many stocks as we can. We read hedge fund investor letters and listen to stock pitches at hedge fund conferences. If you want to find out the best healthcare stock to buy right now, you can watch our latest hedge fund manager interview here. Keeping this in mind let's take a look at the key hedge fund action regarding Houghton Mifflin Harcourt Co (NASDAQ:HMHC).

Hedge fund activity in Houghton Mifflin Harcourt Co (NASDAQ:HMHC)

At Q1's end, a total of 20 of the hedge funds tracked by Insider Monkey were long this stock, a change of -9% from the previous quarter. The graph below displays the number of hedge funds with bullish position in HMHC over the last 18 quarters. So, let's review which hedge funds were among the top holders of the stock and which hedge funds were making big moves.

Is HMHC A Good Stock To Buy?
Is HMHC A Good Stock To Buy?

More specifically, Anchorage Advisors was the largest shareholder of Houghton Mifflin Harcourt Co (NASDAQ:HMHC), with a stake worth $36.6 million reported as of the end of September. Trailing Anchorage Advisors was Water Street Capital, which amassed a stake valued at $11.1 million. Freshford Capital Management, Corsair Capital Management, and Nishkama Capital were also very fond of the stock, becoming one of the largest hedge fund holders of the company. In terms of the portfolio weights assigned to each position Gratia Capital allocated the biggest weight to Houghton Mifflin Harcourt Co (NASDAQ:HMHC), around 5.47% of its 13F portfolio. Nishkama Capital is also relatively very bullish on the stock, designating 3.09 percent of its 13F equity portfolio to HMHC.

Judging by the fact that Houghton Mifflin Harcourt Co (NASDAQ:HMHC) has witnessed bearish sentiment from the aggregate hedge fund industry, logic holds that there were a few hedge funds who were dropping their full holdings by the end of the first quarter. At the top of the heap, Jon Bauer's Contrarian Capital said goodbye to the largest investment of the 750 funds monitored by Insider Monkey, valued at about $3 million in stock. Peter Algert and Kevin Coldiron's fund, Algert Coldiron Investors, also dumped its stock, about $0.4 million worth. These transactions are important to note, as aggregate hedge fund interest fell by 2 funds by the end of the first quarter.

Let's now take a look at hedge fund activity in other stocks - not necessarily in the same industry as Houghton Mifflin Harcourt Co (NASDAQ:HMHC) but similarly valued. We will take a look at PAR Technology Corporation (NYSE:PAR), RGC Resources, Inc. (NASDAQ:RGCO), Golar LNG Partners LP (NASDAQ:GMLP), and Sunlands Technology Group (NYSE:STG). This group of stocks' market valuations match HMHC's market valuation.

[table] Ticker, No of HFs with positions, Total Value of HF Positions (x1000), Change in HF Position PAR,8,65546,-4 RGCO,1,1820,0 GMLP,7,22587,0 STG,2,445,0 Average,4.5,22600,-1 [/table]

View table here if you experience formatting issues.

As you can see these stocks had an average of 4.5 hedge funds with bullish positions and the average amount invested in these stocks was $23 million. That figure was $68 million in HMHC's case. PAR Technology Corporation (NYSE:PAR) is the most popular stock in this table. On the other hand RGC Resources, Inc. (NASDAQ:RGCO) is the least popular one with only 1 bullish hedge fund positions. Compared to these stocks Houghton Mifflin Harcourt Co (NASDAQ:HMHC) is more popular among hedge funds. Our calculations showed that top 10 most popular stocks among hedge funds returned 41.4% in 2019 and outperformed the S&P 500 ETF (SPY) by 10.1 percentage points. These stocks gained 18.6% in 2020 through July 27th and still beat the market by 17.1 percentage points. Unfortunately HMHC wasn't nearly as popular as these 10 stocks and hedge funds that were betting on HMHC were disappointed as the stock returned 15.4% since the end of the first quarter and underperformed the market. If you are interested in investing in large cap stocks with huge upside potential, you should check out the top 10 most popular stocks among hedge funds as most of these stocks already outperformed the market in 2020.

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

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