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Is Zscaler, Inc. (ZS) A Good Stock To Buy?

Asma UL Husna

The first quarter was a breeze as Powell pivoted, and China seemed eager to reach a deal with Trump. Both the S&P 500 and Russell 2000 delivered very strong gains as a result, with the Russell 2000, which is composed of smaller companies, outperforming the large-cap stocks slightly during the first quarter. Unfortunately sentiment shifted in May and August as this time China pivoted and Trump put more pressure on China by increasing tariffs. Fourth quarter brought optimism to the markets and hedge funds' top 20 stock picks performed spectacularly in this volatile environment. These stocks delivered a total gain of 37.4% through the end of November, vs. a gain of 27.5% for the S&P 500 ETF. In this article we will look at how this market volatility affected the sentiment of hedge funds towards Zscaler, Inc. (NASDAQ:ZS), and what that likely means for the prospects of the company and its stock.

Is Zscaler, Inc. (NASDAQ:ZS) a superb investment today? Money managers are getting less bullish. The number of bullish hedge fund bets decreased by 5 lately. Our calculations also showed that ZS 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

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_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 go over the key hedge fund action encompassing Zscaler, Inc. (NASDAQ:ZS).

Hedge fund activity in Zscaler, Inc. (NASDAQ:ZS)

Heading into the fourth quarter of 2019, a total of 20 of the hedge funds tracked by Insider Monkey were long this stock, a change of -20% from one quarter earlier. On the other hand, there were a total of 28 hedge funds with a bullish position in ZS 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.

Among these funds, Two Sigma Advisors held the most valuable stake in Zscaler, Inc. (NASDAQ:ZS), which was worth $46.4 million at the end of the third quarter. On the second spot was Citadel Investment Group which amassed $15.9 million worth of shares. Arrowstreet Capital, Castle Hook Partners, and Alkeon 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 Mark Asset Management allocated the biggest weight to Zscaler, Inc. (NASDAQ:ZS), around 1.17% of its 13F portfolio. Castle Hook Partners is also relatively very bullish on the stock, setting aside 0.47 percent of its 13F equity portfolio to ZS.

Due to the fact that Zscaler, Inc. (NASDAQ:ZS) has witnessed declining sentiment from the entirety of the hedge funds we track, it's safe to say that there is a sect of hedgies that slashed their positions entirely in the third quarter. At the top of the heap, Renaissance Technologies cut the biggest position of all the hedgies monitored by Insider Monkey, comprising about $54.6 million in stock. Richard Driehaus's fund, Driehaus Capital, also cut its stock, about $23.6 million worth. These bearish behaviors are interesting, as total hedge fund interest fell by 5 funds in the third quarter.

Let's also examine hedge fund activity in other stocks similar to Zscaler, Inc. (NASDAQ:ZS). These stocks are Ares Management Corporation (NYSE:ARES), Mellanox Technologies, Ltd. (NASDAQ:MLNX), Park Hotels & Resorts Inc. (NYSE:PK), and EnCana Corporation (NYSE:ECA). This group of stocks' market valuations are similar to ZS's market valuation.

[table] Ticker, No of HFs with positions, Total Value of HF Positions (x1000), Change in HF Position ARES,17,222255,7 MLNX,39,1506689,0 PK,19,378136,-6 ECA,25,262404,-7 Average,25,592371,-1.5 [/table]

View table here if you experience formatting issues.

As you can see these stocks had an average of 25 hedge funds with bullish positions and the average amount invested in these stocks was $592 million. That figure was $134 million in ZS's case. Mellanox Technologies, Ltd. (NASDAQ:MLNX) is the most popular stock in this table. On the other hand Ares Management Corporation (NYSE:ARES) is the least popular one with only 17 bullish hedge fund positions. Zscaler, Inc. (NASDAQ:ZS) is not the least popular stock in this group but hedge fund interest is still below average. 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. A small number of hedge funds were also right about betting on ZS, though not to the same extent, as the stock returned 10.3% during the first two months of the fourth quarter and outperformed the market.

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

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