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Were Hedge Funds Right About Flocking Into Discover Financial Services (DFS)?

Asma UL Husna

At Insider Monkey we track the activity of some of the best-performing hedge funds like Appaloosa Management, Baupost, and Tiger Global because we determined that some of the stocks that they are collectively bullish on can help us generate returns above the broader indices. Out of thousands of stocks that hedge funds invest in, small-caps can provide the best returns over the long term due to the fact that these companies are less efficiently priced and are usually under the radars of mass-media, analysts and dumb money. This is why we follow the smart money moves in the small-cap space.

Is Discover Financial Services (NYSE:DFS) the right investment to pursue these days? Money managers are turning bullish. The number of long hedge fund bets increased by 5 in recent months. Our calculations also showed that DFS isn't among the 30 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' large-cap stock picks indeed failed to beat the market between 1999 and 2016. However, we were able to identify in advance a select group of hedge fund holdings that outperformed the market by 32 percentage points since May 2014 through March 12, 2019 (see the details here). We were also able to identify in advance a select group of hedge fund holdings that'll significantly underperform the market. We have been tracking and sharing the list of these stocks since February 2017 and they lost 27.5% through March 12, 2019. That's why we believe hedge fund sentiment is an extremely useful indicator that investors should pay attention to.

Phill Gross, Adage Capital Management

Let's review the key hedge fund action surrounding Discover Financial Services (NYSE:DFS).

What have hedge funds been doing with Discover Financial Services (NYSE:DFS)?

At Q4's end, a total of 37 of the hedge funds tracked by Insider Monkey were long this stock, a change of 16% from the second quarter of 2018. On the other hand, there were a total of 37 hedge funds with a bullish position in DFS a year ago. So, let's review which hedge funds were among the top holders of the stock and which hedge funds were making big moves.

DFS_mar2019

Among these funds, Diamond Hill Capital held the most valuable stake in Discover Financial Services (NYSE:DFS), which was worth $387.3 million at the end of the third quarter. On the second spot was Arrowstreet Capital which amassed $75.3 million worth of shares. Moreover, GLG Partners, Millennium Management, and Adage Capital Management were also bullish on Discover Financial Services (NYSE:DFS), allocating a large percentage of their portfolios to this stock.

As aggregate interest increased, key hedge funds were leading the bulls' herd. Hawkeye Capital, managed by Richard Rubin, initiated the largest position in Discover Financial Services (NYSE:DFS). Hawkeye Capital had $15.3 million invested in the company at the end of the quarter. Peter Seuss's Prana Capital Management also initiated a $7.7 million position during the quarter. The following funds were also among the new DFS investors: Matthew Tewksbury's Stevens Capital Management, Gregg Moskowitz's Interval Partners, and Matthew Lindenbaum's Basswood Capital.

Let's go over hedge fund activity in other stocks - not necessarily in the same industry as Discover Financial Services (NYSE:DFS) but similarly valued. We will take a look at Kellogg Company (NYSE:K), Parker-Hannifin Corporation (NYSE:PH), Willis Towers Watson Public Limited Company (NASDAQ:WLTW), and The Clorox Company (NYSE:CLX). This group of stocks' market values are similar to DFS's market value.

[table] Ticker, No of HFs with positions, Total Value of HF Positions (x1000), Change in HF Position K,27,329154,2 PH,30,513662,3 WLTW,25,1442354,-8 CLX,28,1026937,6 Average,27.5,828027,0.75 [/table]

View table here if you experience formatting issues.

As you can see these stocks had an average of 27.5 hedge funds with bullish positions and the average amount invested in these stocks was $828 million. That figure was $741 million in DFS's case. Parker-Hannifin Corporation (NYSE:PH) is the most popular stock in this table. On the other hand Willis Towers Watson Public Limited Company (NASDAQ:WLTW) is the least popular one with only 25 bullish hedge fund positions. Compared to these stocks Discover Financial Services (NYSE:DFS) is more popular among hedge funds. Hedge funds were right about flocking into DFS. Our calculations showed that top 15 most popular stocks among hedge funds returned 19.7% through March 15th and outperformed the S&P 500 ETF (SPY) by 6.6 percentage points. Hedge funds were also right about betting on DFS as the stock returned 24.7% and outperformed the market as well.

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

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