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Hedge Funds Are Nibbling On Discover Financial Services (DFS)

Asma UL Husna
·7 mins read

At the end of February we announced the arrival of the first US recession since 2009 and we predicted that the market will decline by at least 20% in (see why hell is coming). We reversed our stance on March 25th after seeing unprecedented fiscal and monetary stimulus unleashed by the Fed and the Congress. This is the perfect market for stock pickers, now that the stocks are fully valued again. In these volatile markets we scrutinize hedge fund filings to get a reading on which direction each stock might be going. In this article, we will take a closer look at hedge fund sentiment towards Discover Financial Services (NYSE:DFS) at the end of the second quarter and determine whether the smart money was really smart about this stock.

Is Discover Financial Services (NYSE:DFS) going to take off soon? Money managers were buying. The number of long hedge fund bets advanced by 4 recently. Discover Financial Services (NYSE:DFS) was in 44 hedge funds' portfolios at the end of the second quarter of 2020. The all time high for this statistics is 52. Our calculations also showed that DFS isn't among the 30 most popular stocks among hedge funds (click for Q2 rankings and see the video for a quick look at the top 5 stocks). There were 40 hedge funds in our database with DFS holdings at the end of March. Video: Watch our video about the top 5 most popular hedge fund stocks.

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 S&P 500 ETFs by more than 56 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. Even if you aren't comfortable with shorting stocks, you should at least avoid initiating long positions in stocks that are in our short portfolio.

Ken Griffin CITADEL INVESTMENT GROUP
Ken Griffin CITADEL INVESTMENT GROUP

Ken Griffin of Citadel Investment Group

At Insider Monkey we scour multiple sources to uncover the next great investment idea. For example, legal marijuana is one of the fastest growing industries right now, so we are checking out stock pitches like “the Starbucks of cannabis” to identify the next tenbagger. Federal Reserve has been creating trillions of dollars electronically to keep the interest rates near zero. We believe this will lead to inflation and boost precious metals prices. So, we are checking out this junior gold mining stock. We read hedge fund investor letters and listen to stock pitches at hedge fund conferences. 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. Keeping this in mind let's take a look at the key hedge fund action encompassing Discover Financial Services (NYSE:DFS).

How have hedgies been trading Discover Financial Services (NYSE:DFS)?

Heading into the third quarter of 2020, a total of 44 of the hedge funds tracked by Insider Monkey were long this stock, a change of 10% from the first quarter of 2020. The graph below displays the number of hedge funds with bullish position in DFS over the last 20 quarters. With hedge funds' positions undergoing their usual ebb and flow, there exists a select group of notable hedge fund managers who were increasing their holdings significantly (or already accumulated large positions).

According to Insider Monkey's hedge fund database, Eashwar Krishnan's Tybourne Capital Management has the biggest position in Discover Financial Services (NYSE:DFS), worth close to $198.7 million, amounting to 6% of its total 13F portfolio. The second largest stake is held by Lone Pine Capital, with a $102 million position; 0.5% of its 13F portfolio is allocated to the company. Remaining professional money managers with similar optimism contain Ike Kier and Ilya Zaides's KG Funds Management, Ken Griffin's Citadel Investment Group and James Parsons's Junto Capital Management. In terms of the portfolio weights assigned to each position KG Funds Management allocated the biggest weight to Discover Financial Services (NYSE:DFS), around 8.75% of its 13F portfolio. East Side Capital (RR Partners) is also relatively very bullish on the stock, earmarking 6.43 percent of its 13F equity portfolio to DFS.

With a general bullishness amongst the heavyweights, key hedge funds were leading the bulls' herd. Tybourne Capital Management, managed by Eashwar Krishnan, initiated the biggest position in Discover Financial Services (NYSE:DFS). Tybourne Capital Management had $198.7 million invested in the company at the end of the quarter. Lone Pine Capital also made a $102 million investment in the stock during the quarter. The other funds with brand new DFS positions are Ike Kier and Ilya Zaides's KG Funds Management, James Parsons's Junto Capital Management, and Kevin D. Eng's Columbus Hill Capital Management.

Let's check out hedge fund activity in other stocks similar to Discover Financial Services (NYSE:DFS). These stocks are Vulcan Materials Company (NYSE:VMC), Telefonica Brasil SA (NYSE:VIV), Quest Diagnostics Incorporated (NYSE:DGX), Cardinal Health, Inc. (NYSE:CAH), Tractor Supply Company (NASDAQ:TSCO), CBRE Group, Inc. (NYSE:CBRE), and BioNTech SE (NASDAQ:BNTX). All of these stocks' market caps match DFS's market cap.

[table] Ticker, No of HFs with positions, Total Value of HF Positions (x1000), Change in HF Position VMC,51,879902,2 VIV,12,99788,4 DGX,46,804000,8 CAH,49,956785,5 TSCO,38,828499,1 CBRE,29,1442786,-4 BNTX,15,367554,9 Average,34.3,768473,3.6 [/table]

View table here if you experience formatting issues.

As you can see these stocks had an average of 34.3 hedge funds with bullish positions and the average amount invested in these stocks was $768 million. That figure was $741 million in DFS's case. Vulcan Materials Company (NYSE:VMC) is the most popular stock in this table. On the other hand Telefonica Brasil SA (NYSE:VIV) is the least popular one with only 12 bullish hedge fund positions. Discover Financial Services (NYSE:DFS) is not the most popular stock in this group but hedge fund interest is still above average. Our overall hedge fund sentiment score for DFS is 75.4. Stocks with higher number of hedge fund positions relative to other stocks as well as relative to their historical range receive a higher sentiment score. This is a slightly positive signal but we'd rather spend our time researching stocks that hedge funds are piling on. 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 33% in 2020 through the end of August and beat the market by 23.2 percentage points. Unfortunately DFS wasn't nearly as popular as these 10 stocks and hedge funds that were betting on DFS were disappointed as the stock returned 6.9% during the same time period 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 many of these stocks already outperformed the market so far this year.

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

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