The market has been volatile in the last few months as the Federal Reserve finalized its rate cuts and uncertainty looms over trade negotiations with China. Small cap stocks have been hit hard as a result, as the Russell 2000 ETF (IWM) has underperformed the larger S&P 500 ETF (SPY) by more than 10 percentage points over the last 12 months. SEC filings and hedge fund investor letters indicate that the smart money seems to be paring back their overall long exposure since summer months, though some funds increased their exposure dramatically at the end of Q3 and the beginning of Q4. In this article, we analyze what the smart money thinks of SmileDirectClub, Inc. (NASDAQ:SDC) and find out how it is affected by hedge funds' moves.
SmileDirectClub, Inc. (NASDAQ:SDC) has seen an increase in activity from the world's largest hedge funds recently. Our calculations also showed that SDC 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.
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 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. 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.
[caption id="attachment_337892" align="aligncenter" width="500"] Lei Zhang of Hillhouse Capital Management[/caption]
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 glance at the new hedge fund action surrounding SmileDirectClub, Inc. (NASDAQ:SDC).
How are hedge funds trading SmileDirectClub, Inc. (NASDAQ:SDC)?
Heading into the fourth quarter of 2019, a total of 28 of the hedge funds tracked by Insider Monkey held long positions in this stock, a change of 28 from one quarter earlier. On the other hand, there were a total of 0 hedge funds with a bullish position in SDC a year ago. So, let's examine which hedge funds were among the top holders of the stock and which hedge funds were making big moves.
The largest stake in SmileDirectClub, Inc. (NASDAQ:SDC) was held by Citadel Investment Group, which reported holding $41.9 million worth of stock at the end of September. It was followed by Hillhouse Capital Management with a $40.6 million position. Other investors bullish on the company included Millennium Management, Point72 Asset Management, and Balyasny Asset Management. In terms of the portfolio weights assigned to each position Kamunting Street Capital allocated the biggest weight to SmileDirectClub, Inc. (NASDAQ:SDC), around 1.59% of its portfolio. Element Capital Management is also relatively very bullish on the stock, dishing out 1.21 percent of its 13F equity portfolio to SDC.
As industrywide interest jumped, specific money managers have been driving this bullishness. Citadel Investment Group, managed by Ken Griffin, established the biggest position in SmileDirectClub, Inc. (NASDAQ:SDC). Citadel Investment Group had $41.9 million invested in the company at the end of the quarter. Lei Zhang's Hillhouse Capital Management also made a $40.6 million investment in the stock during the quarter. The following funds were also among the new SDC investors: Israel Englander's Millennium Management, Steve Cohen's Point72 Asset Management, and Dmitry Balyasny's Balyasny Asset Management.
Let's go over hedge fund activity in other stocks similar to SmileDirectClub, Inc. (NASDAQ:SDC). These stocks are Primerica, Inc. (NYSE:PRI), Aluminum Corp. of China Limited (NYSE:ACH), Parsley Energy Inc (NYSE:PE), and Trex Company, Inc. (NYSE:TREX). This group of stocks' market caps match SDC's market cap.
[table] Ticker, No of HFs with positions, Total Value of HF Positions (x1000), Change in HF Position PRI,23,340762,-3 ACH,3,4206,-2 PE,44,778914,8 TREX,18,104493,-1 Average,22,307094,0.5 [/table]
View table here if you experience formatting issues.
As you can see these stocks had an average of 22 hedge funds with bullish positions and the average amount invested in these stocks was $307 million. That figure was $288 million in SDC's case. Parsley Energy Inc (NYSE:PE) is the most popular stock in this table. On the other hand Aluminum Corp. of China Limited (NYSE:ACH) is the least popular one with only 3 bullish hedge fund positions. SmileDirectClub, Inc. (NASDAQ:SDC) 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. 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 SDC wasn't nearly as popular as these 20 stocks and hedge funds that were betting on SDC were disappointed as the stock returned -28.2% during the fourth quarter (through the end of November) 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 many of these stocks already outperformed the market so far this year.
Disclosure: None. This article was originally published at Insider Monkey.