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Is Paychex, Inc. (PAYX) Going to Burn These Hedge Funds?

Asma UL Husna

Hedge funds are known to underperform the bull markets but that's not because they are terrible at stock picking. Hedge funds underperform because their net exposure in only 40-70% and they charge exorbitant fees. No one knows what the future holds and how market participants will react to the bountiful news that floods in each day. However, hedge funds' consensus picks on average deliver market beating returns. For example the Standard and Poor’s 500 Total Return Index ETFs returned 27.5% (including dividend payments) through the end of November. Conversely, hedge funds’ top 20 large-cap stock picks generated a return of nearly 37.4% during the same period, with the majority of these stock picks outperforming the broader market benchmark. Interestingly, an average long/short hedge fund returned only a fraction of this value due to the hedges they implemented and the large fees they charged. If you pay attention to the actual hedge fund returns versus the returns of their long stock picks, you might believe that it is a waste of time to analyze hedge funds' purchases. We know better. That's why we scrutinize hedge fund sentiment before we invest in a stock like Paychex, Inc. (NASDAQ:PAYX).

Paychex, Inc. (NASDAQ:PAYX) was in 28 hedge funds' portfolios at the end of September. PAYX has seen a decrease in support from the world's most elite money managers recently. There were 34 hedge funds in our database with PAYX holdings at the end of the previous quarter. Our calculations also showed that PAYX isn't among the 30 most popular stocks among hedge funds (click for Q3 rankings and see the video below for Q2 rankings). Video: Click the image to watch our video about the top 5 most popular hedge fund stocks.

5 Most Popular Stocks Among Hedge Funds

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 Russell 2000 ETFs by 40 percentage points since May 2014 (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.

[caption id="attachment_673876" align="aligncenter" width="473"] John Overdeck of Two Sigma Advisors[/caption]

John Overdeck of Two Sigma

Unlike the largest US hedge funds that are convinced Dow will soar past 40,000 or the world's most bearish hedge fund that's more convinced than ever that a crash is coming, our long-short investment strategy doesn't rely on bull or bear markets to deliver double digit returns. We only rely on the best performing hedge funds' buy/sell signals. We're going to take a look at the new hedge fund action encompassing Paychex, Inc. (NASDAQ:PAYX).

What have hedge funds been doing with Paychex, Inc. (NASDAQ:PAYX)?

At Q3's end, a total of 28 of the hedge funds tracked by Insider Monkey held long positions in this stock, a change of -18% from the previous quarter. By comparison, 30 hedge funds held shares or bullish call options in PAYX a year ago. With hedge funds' positions undergoing their usual ebb and flow, there exists a few key hedge fund managers who were upping their stakes significantly (or already accumulated large positions).

PAYX_dec2019

Among these funds, Select Equity Group held the most valuable stake in Paychex, Inc. (NASDAQ:PAYX), which was worth $279.7 million at the end of the third quarter. On the second spot was Arrowstreet Capital which amassed $170.6 million worth of shares. Two Sigma Advisors, Millennium Management, and Echo Street Capital Management 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 Select Equity Group allocated the biggest weight to Paychex, Inc. (NASDAQ:PAYX), around 1.89% of its portfolio. Prospector Partners is also relatively very bullish on the stock, designating 0.99 percent of its 13F equity portfolio to PAYX.

Because Paychex, Inc. (NASDAQ:PAYX) has experienced a decline in interest from the entirety of the hedge funds we track, it's easy to see that there is a sect of funds that decided to sell off their full holdings in the third quarter. Interestingly, Peter Muller's PDT Partners sold off the largest position of all the hedgies watched by Insider Monkey, valued at about $9.8 million in stock. Donald Sussman's fund, Paloma Partners, also sold off its stock, about $6.6 million worth. These bearish behaviors are interesting, as total hedge fund interest was cut by 6 funds in the third quarter.

Let's now take a look at hedge fund activity in other stocks similar to Paychex, Inc. (NASDAQ:PAYX). We will take a look at MPLX LP (NYSE:MPLX), Brown-Forman Corporation (NYSE:BF), IQVIA Holdings, Inc. (NYSE:IQV), and The Williams Companies, Inc. (NYSE:WMB). This group of stocks' market valuations match PAYX's market valuation.

[table] Ticker, No of HFs with positions, Total Value of HF Positions (x1000), Change in HF Position MPLX,13,486509,2 BF,21,632843,-7 IQV,64,4469195,-3 WMB,36,643068,2 Average,33.5,1557904,-1.5 [/table]

View table here if you experience formatting issues.

As you can see these stocks had an average of 33.5 hedge funds with bullish positions and the average amount invested in these stocks was $1558 million. That figure was $871 million in PAYX's case. IQVIA Holdings, Inc. (NYSE:IQV) is the most popular stock in this table. On the other hand MPLX LP (NYSE:MPLX) is the least popular one with only 13 bullish hedge fund positions. Paychex, Inc. (NASDAQ:PAYX) is not the least popular stock in this group but hedge fund interest is still below average. This is a slightly negative signal and we'd rather spend our time researching stocks that hedge funds are piling on. Our calculations showed that top 20 most popular stocks among hedge funds returned 37.4% in 2019 through the end of November and outperformed the S&P 500 ETF (SPY) by 9.9 percentage points. Unfortunately PAYX wasn't nearly as popular as these 20 stocks (hedge fund sentiment was quite bearish); PAYX investors were disappointed as the stock returned 4.8% during the first two months of the fourth 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 20 most popular stocks among hedge funds as 70 percent of these stocks already outperformed the market in Q4.

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

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