Did Social Media Predict Carl Icahn’s Biggest Trades?

The following article was written by our guest author Insider Monkey. There are a select few money managers whose words can move entire markets, but up to this point, only one has mastered the medium of Twitter [TWTR]: Carl Icahn. After creating an account earlier this year, the billionaire has disclosed a few big positions on the micro blogging site, including a purchase of Apple [AAPL] and a sale of Netflix [NFLX] stock.

While the media has had a lot to say about Icahn’s Twitter account, no one has taken the time to examine his trades in terms of social media sentiment. For someone who is likely the world’s most socially active hedge fund manager, surprisingly little analysis has been done in this realm.

With the help of Market Prophit, a company that converts stock-related social media posts into easy-to-read data, we’re able to look at how much chatter Icahn’s biggest trades created. More interestingly, it appears that some of this buzz actually predicted the moves before they happened.

Netflix

Netflix was the recipient of a major cut by Icahn late last month. In a 13D filing and subsequent tweet after the market’s close on October 22nd, the investor reported a 4.5% stake in the streaming video company, about half of what he previously owned. This move came 24 hours after Netflix’s stock price had surged on promising third quarter earnings.

Market Prophit’s CEO, Igor Gonta, revealed to us that on the morning of the 22nd, social media circles were already buzzing about a major seller “doing large block sales” of Netflix, and Icahn’s name was visibly in the rumor mill. By the time the market had closed, Icahn’s official SEC disclosure pressed the stock to drop almost all of its gains from the previous day’s earnings report.

Apple

Any analysis of Carl Icahn and Twitter must include Apple. On the afternoon of August 13th this year, Icahn tweeted that he had a “large position” in the tech giant on the basis of undervaluation, adding that a conversation with Tim Cook was on the table. As Gonta pointed out to us, shares of Apple rallied by nearly 2.5% just 20 minutes after Icahn’s initial tweet, and social media sentiment turned positive approximately two minutes prior to the reveal (see graph here).

The next major event on the Icahn-Apple timeline was on October 1st. Halfway through the morning on this date, Icahn tweeted about the dinner he had with Tim Cook the night before, in which he reiterated his desire for Apple to pursue a $150 billion share buyback plan.

Market Prophit again picked up on bullish chatter before Icahn’s tweet went live at 10:23am. This time, an uptick in positive social chatter led the tweet by a full 40 minutes, and shares of Apple had already risen by almost one full percentage point by half past ten. According to Gonta, social media sentiment turned negative immediately following Icahn’s tweet “because the price had already run up,” indicating that a classic “sell the news” phenomenon had just taken place.

Sitting here in early November, it’s unknown if Icahn will succeed in his quest to convince Apple that a larger buyback will lead to a $1,250 stock price. What we can say with confidence, though, is if the hedge fund manager is active on Twitter again, social media chatter may predict it.

Disclosure: none

Why Warren Buffett Won’t Buy Twitter

By Guest Author Insider Monkey. It’s widely assumed that Warren Buffett doesn’t invest in technology stocks, but in recent years, this belief has contrasted with reality. After accounting for zero percent of his equity portfolio at the end of 2010, the tech sector now makes up one sixth of Buffett’s stock holdings. At Insider Monkey, we’ve discovered that hedge funds and other prominent investors’ best stock picks exhibit market-beating potential, so it’s worth paying attention to these developments.

In the case of Buffett and Berkshire Hathaway, they're not your typical technology investors. They follow a very strict set of rules when selecting investments in this space, which, through our observations, boil down to finding tech companies that: (1) trade at very cheap multiples, (2) pay a dividend, and (3) have sustainable product offerings that will safeguard their survival over the next 15 to 20 years.

With this in mind, the next logical question in many Buffettologists’ minds is: will the Oracle buy shares of Twitter [TWTR] once it becomes a publicly traded entity?

This was the same question many Facebook [FB] enthusiasts asked after its IPO last year and to no surprise, many mega-investors bought in. Buffett didn’t, however, and it is evident that Facebook broke all three of the rules described above. The stock traded at more than 70 times earnings upon going public and there simply wasn’t any assurance that it wouldn’t go the route of MySpace, Digg, Xanga and the rest of social media’s fallen giants. It also didn’t offer a dividend, and still doesn’t to this day.

Twitter faces all three of the same problems.

According to most estimates, Twitter will be valued near $11 billion when it goes public, giving it a per share value between $19 and $20. At this price, the company will theoretically trade at about 18.3 times this year’s estimated revenue, which most conservative analysts expect to be around $600 million.

Facebook, meanwhile, is valued at a price-to-sales multiple near this mark, while LinkedIn [LNKD] is also in the same vicinity. It’s unreasonable to expect that Buffett would be attracted to a valuation in this range if he hasn’t been before.

Equally as important, we also expect that the billionaire will take issue with Twitter’s outlook over the next 15 to 20 years. While some may argue that the micro blogging service can generate more advertising revenue than a Facebook or a LinkedIn for example, there’s still no guarantee that Twitter will be around in two decades. Obviously, there’s no such thing as 100% certainty in any industry, but there are fewer risks facing Buffett’s favorite investments, like Wells Fargo [WFC] and Coca Cola [KO], than there are to any social media company.

Putting the final nail in the proverbial coffin, we also know that from Twitter’s S-1 filing, it has no plans to declare dividends “in the foreseeable future.”

So, if Warren Buffett won’t buy Twitter, what stock is responsible for the majority of his investment in the tech sector?

As reported in his latest 13F filing, the answer is IBM [IBM]. Buffett and Berkshire hold almost 15% of their $89 billion equity portfolio in the information technology giant, and it meets all three of our aforementioned criteria. IBM trades at a mere 9.9 times forward earnings, has five diversified business segments from IT infrastructure to software, and it pays a dividend yield above 2%.

Disclosure: none

4 Hedge Funds Heavily Invested in Apple’s Fate

Written By Guest Author Insider Monkey. There are more than 8,000 hedge funds in existence today, and of this group, we at Insider Monkey track close to 600 of the best and brightest. The best picks of the best hedge fund managers have market-beating potential (see how we returned 47.6% in one year), and within this group, there are many ways to parse the data.

This week, we’ve covered some important tech topics in particular, like why Warren Buffett probably won’t buy Twitter [TWTR] and the peculiarities of Longbow Securities’ moves in NQ Mobile [NQ]. One subject that has been flying under the radar, though, is Apple [AAPL] and the hedge funds that surround it.

According to one Apple news site, the tech giant’s latest earnings release has been met with mostly optimism on Wall Street, especially from JPMorgan’s Mark Moskowitz. Moskowitz expects Apple’s current share price to hit $600 by December of 2014, primarily based on strong iPhone sales, the iPad’s potential in future quarters, and gross margins that are “good enough for long-term investors.”

With that in mind, we thought it’d be useful to run through the hedge fund managers that have stayed committed to Apple over the long run. Here are the four biggest bulls that have held the stock for at least two years:

David Einhorn

David Einhorn first bought Apple in the second quarter of 2010 and in the three years since, the manager of Greenlight Capital has upped his stake by nearly eightfold. While Tim Cook and the rest of Apple’s leadership didn’t adopt Einhorn’s iPref idea, his latest Q3 shareholder letter reveals he’ll likely remain bullish here for the “longer-term.”

David Shaw

Another billionaire, David E. Shaw, has held shares of Apple for the better part of the last decade. The manager of D.E. Shaw & Co doubled his exposure to the stock in the last round of 13F filings, and it actually represents the largest long-only holding in his entire equity portfolio. Shaw and Einhorn have the two largest Apple stakes of the funds we track, both of which represent nearly $1 billion in market value apiece.

Philippe Laffont

Philippe Laffont’s Coatue Management, meanwhile, has been a major Apple investor since the fourth quarter of 2004. Laffont founded his tech-focused hedge fund in 1999 after working for the legendary Julian Robertson, and Apple was his top stock pick for all of 2011 and most of 2012 before he slashed over half of his stake in the fourth quarter.

The fund manager now owns over $600 million in Apple stock and has recouped all of the shares he sold at the end of last year. While we don’t know exactly when Laffont cut his stake in 2012, it’s evident that he avoided much of the swoon that plagued investors who stuck with their gut, and actually bought back when shares were cheaper.

Ken Fisher

Although he’s technically not a hedge fund manager, Ken Fisher is a prominent investor worth tracking. Fisher Asset Management oversees nearly $40 billion in equity investments alone, and while it has been a long-term shareholder of Apple, the firm has only recently upped its stake to significant levels. At the halfway point of 2012, Fisher held $50 million worth of Apple stock; today, that number is more than $600 million.

It’s no secret that Fisher likes growth stocks that also trade at reasonable valuations, so we can understand why he’s bullish here. Apple trades at a PEG ratio near 0.9, and the sell-side still expects it to generate earnings growth of 15% a year over the next half-decade. That forecast trumps peers like Google [GOOG] and Microsoft [MSFT], and it’s cheaper than both.

Disclosure: none

5 Banks Warren Buffett is Betting on for 2014

By our guest contributor Insider Monkey. As we begin to ponder what sectors will rule the markets in 2014, technology, healthcare and industrials are areas that many pundits point to. If you ask Warren Buffett, though, he’ll provide a decidedly different answer.

On CNBC earlier this week, Buffett gave a ringing endorsement to large-cap banks, revealing that he thinks they’re “in best shape [he] can remember.” While anyone who tracks Berkshire Hathaway’s equity portfolio probably had a hunch Buffett is upbeat on banks—over 40% of his holdings are invested in the financial sector—these new comments indicate we should expect his bullishness to continue into next year.

By focusing on the best picks of the best hedge funds and other elite investors, it’s possible for retail investors to beat the market over the long-term (discover the data behind this phenomenon). Buffett is the cream of the crop and in light of his recent comments, we should take note of how he’s playing the banks.

Wells Fargo [WFC] is unequivocally the billionaire’s biggest banking bet, and his largest equity holding at that. The global giant is lauded for its management practices and simple business model, and its connection to Buffett has helped it land financing and advisory roles in multiple Berkshire acquisitions.

While shares of Wells Fargo are up nearly 25% year-to-date and the bank did beat Wall Street’s third quarter earnings estimates, its home lending business has been hurt by falling mortgage applications. Still, Wells’ long-term growth prospects and scale advantages remain intact, and Buffett has to love its price at a mere 10.6 times forward EPS. Don’t ignore the 2.8% dividend yield either; it's the best payout among the ‘Big Four.’

US Bancorp [USB] is Buffett’s No. 2 bank holding. Due to its attractive valuation, solid dividend yield, and strong growth prospects, many analysts know this regional player as a mini-Wells Fargo. In fact, US Bancorp is the only big bank that generates higher ROE and ROA figures than Buffett’s top pick.

His investment in Goldman Sachs [GS], meanwhile, now represents a major portion of Berkshire’s stock holdings. We discussed the intricacies of Buffett’s new $2 billion investment in Goldman here on MarketWatch last week, but all you need to know is that he doesn’t plan to close it any time soon.

The investment banking and brokerage firm has sentimental value for the billionaire, and it pays just 12% of its earnings out as dividends. Like Wells Fargo and US Bancorp, Goldman’s growth prospects are extremely cheap at current prices, and the multifaceted nature of its business gives Buffett exposure to an area of the financial sector that his other bank stocks don’t.

M&T Bank [MTB] and Bank of New York Mellon [BK] are a couple more Buffett favorites, and both are actually the final two bank stocks held in the top 20 of Berkshire’s equity portfolio. M&T Bank has been a staple in Buffett’s holdings for more than two decades, and it’s the only large U.S. bank that didn’t trim dividend payments during the financial crisis. The bank’s quarterly profit streak of nearly 40 years is legendary, and it’s no secret that Buffett is a fan of M&T CEO Robert Wilmers.

BNY Mellon, lastly, has been in Buffett and Berkshire’s good graces since the third quarter of 2010, and the stake was increased by 30% in their last 13F filing. The trust bank can see its bottom line improve if interest rates increase in the future. Uncertainty surrounding the fate of borrowing costs over the long-term is one reason why BNY Mellon could be considered undervalued.

Disclosure: none

Will the Best Leon Cooperman Picks Please Stand Up?

By guest contributor Insider Monkey author Jake Mann. It’s not uncommon to hear hedge fund managers and other prominent investors sounding off on the economy, companies they’re invested in, or even why they hate Apple. So when Leon Cooperman, the billionaire head of Omega Advisors, was on CNBC earlier this week discussing his favorite stock picks, it would appear that this was rational advice all viewers should pay attention to.

Except it’s not.

According to our research at Insider Monkey, the best opportunity for hedge fund piggybackers to outperform the market lies in the small-cap space. Our newsletter that follows this strategy returned 47.6% in its first year (learn how we did it here), and longer-term returns are equally as promising.

In his interview on CNBC, Cooperman mentioned five of his top value investments: Sprint (S), AIG (AIG), Qualcomm (QCOM), KKR Financial (KFN) and SandRidge Energy (SD). All of these picks are fine and dandy in their own right, but only the last two are actually small-caps. In addition to KKR and SandRidge, Leon Cooperman has a few other small-cap stock picks that you should know about.

Atlas Energy

Atlas Energy (ATLS) is Cooperman’s top small-cap pick, and sits at the seventh largest position in his $6.5 billion equity portfolio. Richard Driehaus and Jim Simons are a couple other names that hold this oil and gas E&P, which is up 45% year-to-date. Shares of Atlas have had such a good 2013 because of a few factors: 1) MLPs have seen rising interest from traditional institutional investors, 2) more ETFs are looking at this space, 3) dividend yields have been growing, and 4) the macro environment for domestic natural gas, oil and NGLs is very bullish.

In addition to the impressive appreciation, Atlas Energy pays a 3.5% dividend yield that has quadrupled since 2011, and the valuation isn’t overblown at an enterprise value 2.3 times its revenue.

Chimera Investment

Chimera Investment (CIM), on the other hand, is a small-cap REIT that has been held by Cooperman since the second quarter of 2012 (see the full history here). Like the mythological origin of its name suggests, Chimera is a multi-faceted REIT that invests in residential MBS and different types of mortgage loans and it breaths quite a bit of fire with a 12% dividend yield.

Although quarterly dividend payments have fluctuated in value, they’ve been consistent in presence, and free cash flow has more than doubled over the past two years. On average, Wall Street expects funds from operations to grow by 5% to 6% a year over the next half-decade, but be aware that FFO has missed analyst targets in four of Chimera’s past five quarters. Even with the volatility, there’s no denying this REIT’s ridiculously attractive yield.

Atlas Pipeline Partners

Keeping Cooperman’s big bet on Atlas Energy in mind, it’s no surprise that the billionaire is also bullish on another MLP affiliated with the company, Atlas Pipeline Partners (APL). The natural gas processor is the 14th largest holding in Cooperman’s equity portfolio, and shares have had a solid year, up 20.8%.

In comparison to Atlas Energy, Atlas Pipeline’s focus as a full-service midstream company has allowed it to generate about twice the cash as its aforementioned ally, and thus, a higher dividend yield. Atlas Pipeline currently offers a yield of 6.5% on its shares and dividend payments have grown in five consecutive years. 

A couple more

We haven’t even discussed KKR and SandRidge yet. The latter is another oil and gas E&P, but unlike some of Cooperman’s other picks in the energy sector, SandRidge does not currently pay a dividend. With earnings growth of more than 40% expected this year alone, however, there’s much more momentum behind any bullish thesis here, and shares are actually pretty cheaply valued at 1.6 times book and a close parity on a price-to-sales basis.

Cooperman has held SandRidge stock since the fourth quarter of 2012 and depending on when he bought in, he could have booked as much as a 15% return so far on his investment.

KKR Financial, meanwhile, sits just inside Leon Cooperman’s 15 largest holdings and offers a whopping dividend yield of 8%. Yes, they’re up only 3.5% over the past year, but shares of KKR Financial are extremely attractive because of their depressed valuation; they trade at less than 7 times forward earnings and a price-to-earnings growth ratio of a mere 0.6. With double-digit annual earnings growth expected over the next five years and positive free cash flow, dividends appear sustainable.

Disclosure: none

Apple vs. Microsoft: What’s the Smart Money Think?

The following article was written by our guest autor Indider Monkey. Apple (AAPL) versus Microsoft (MSFT). It is a clichéd contest debated by everyone from tech bloggers to university professors. If you follow the equity markets, we’re willing to bet you’ve taken a side once or twice, or at least thought about it. So instead of picking favorites using the same old tired P/E or earnings growth metrics, we are going to give you some information that’s a bit more useful.

We’re talking about hedge fund sentiment.

At Insider Monkey, our goal is to help you understand how to parse down the vast hedge fund industry into insight you can use. Our empirical research on hedge funds has allowed us to hone our small-cap strategy into a market-beating machine. In its first year ended last month, this strategy returned 47.6%, outpacing the S&P 500 by more than 29 percentage points.

The crowd’s pick: Apple

We track a little over 500 of the best and brightest hedge funds in existence (out of around 8,000 total), and in the Apple-Microsoft debate, the consensus filings are intriguing. According to the final numbers from last quarter, Apple was the third most popular stock among the money managers we track, with 122 hedge funds invested. Ninety-two elite hedge funds were long Microsoft at this time.

Relatively speaking, Google (GOOG) was a much more well-liked tech stock last quarter with a whopping 157 hedgies, but both Microsoft and Apple finished in this measure’s top 10, easily outpacing peers like Nokia (NOK) or Intel (INTC). This overarching form of analysis isn’t the only way to compare the duo, though.

Einhorn’s pick: Apple

Within the aggregate data, there are quite a few interesting cases of noteworthy hedge fund managers choosing between the two based on a variety of factors. David Einhorn, for example, chose to go with Apple while closing out of Microsoft last quarter. His rational was explained in his Q2 2013 shareholder letter, in which Greenlight Capital wrote, “Windows 8 appears to be a flop, and a decade of mismanagement has put Microsoft at risk of becoming a shrinking company.” Apple, meanwhile, is still Einhorn’s No. 1 stock pick, accounting for just over 16% of his $5.3 billion equity portfolio.

Yacktman’s pick: Microsoft

One hedge fund manager who feels precisely the opposite is Donald Yacktman. At the Value Investing Congress on Monday, Yacktman—who’s particularly skilled at finding opportunities in the large cap space—said Apple isn’t as cheap as most think, reasoning that it can’t sustain its high profit margins.

Yacktman remarked his "hat's off to Steve Jobs, he hit 4 home runs in a row," to those in attendance, but in response to a question posed by an audience member on why he holds Microsoft but not Apple stock, his response was interesting. Essentially, Yacktman said that Microsoft's profit margins are protected, i.e. there aren't competing viable operating systems or Office products, while Apple's margins are not. Assuming Samsung's smartphones are close substitutes to Apple's iPhone, Cupertino is theoretically more vulnerable to a shift in consumer preferences and/or a prolonged lack of innovation.

Ubben’s pick: Microsoft

Behind the next proverbial door we’ll take a look at Jeff Ubben of ValueAct Capital, an activist investor who has a longer-term focus than many of his corporate raider peers. Ubben and ValueAct took a huge stake in Microsoft back in April, and the position represents close to $2 billion on the books.  In the eyes of most analysts familiar with the matter, it’s widely understood that Ubben’s aim is for Microsoft to concentrate on cultivating its Azure platform to become the top dog of cloud computing.

Ubben was also at the VIC in New York, and his statements on Microsoft echoed those of Yacktman. According to CNNMoney, the crux of his bullish thesis—in addition to the recently approved buyback and dividend boost—is that Microsoft can rely on its enterprise contract staple for the long term. Apple and its peers, on the other hand, “have to run faster every year to keep up,” Ubben said.

Final thoughts

At the end of the day, it’s up to each individual investor to make up his or her own mind about the Apple-Microsoft debate. The elite hedge fund crowd is leaning toward Apple, and Einhorn is sticking with his guns now that Tim Cook and management have shown their shareholders the money.

Apple’s apparently cheap valuation can be called into question, though, if you’re in Yacktman’s camp with regard to margin pressures. Or, if you’re like Ubben and are more confident in Microsoft’s cloud opportunity and existing strengths in enterprise computing, it’s reasonable to feel like the company represents a safer investment than Apple. Either way, the world’s richest investors are split on the matter, and this is a debate that doesn’t look like it will be decided any time soon.

Disclosure: none

Is An ‘Activist Mutual Fund’ A Smart Investment?

The following article was written by our guest author Insider Monkey. At Insider Monkey, we use a number of techniques to track investment activity of hedge funds and other notable investors. Our research has shown that the most popular small cap stocks among hedge funds, as determined by quarterly 13F filings, earn an average excess return of 18 percentage points per year (discover the details of our small-cap strategy). Last summer, we put this theory into practice by publishing a portfolio of the most popular small caps and since inception this portfolio has beaten the S&P 500 by 29 percentage points.

The activist

Investors can also receive more up-to-date information about what hedge fund managers are doing through 13D and 13G filings. 13Ds are also known as activist filings—when a hedge fund such as billionaire Carl Icahn’s Icahn Capital or billionaire Bill Ackman’s Pershing Square files a 13D as opposed to a 13G, it usually signals that it intends to push management to make changes at the company either privately or publicly. While activist campaigns do not always work, often these managers are successful in getting a company to sell itself, spin out a non-core business unit, return more cash to shareholders, or take other actions that increase shareholder value.

They also may benefit from improvements in general market conditions that push up the stock price, as with any other hedge fund investment. The combination of these factors sometimes results in high average returns: Icahn, for example, tends to have done well with his 13D filings in the past couple of years.

Meet one 13D Activist Fund

Northern Lights Distributors, LLC has launched a long-only fund (the 13D Activist Fund) whose managers select stocks from the universe of activist positions. While the fund has a limited performance history, it has outperformed the S&P 500 year to date with a return of 26% compared to the index’s total return of 18%.

The 13D Activist Fund also notes that third-party academic research shows superior performance for activist targets and this is not entirely captured by a pop in the stock price immediately following the announcement. For example, “a further significant increase in share price” occurs after the filing date according to one study on the returns from activism.

To capitalize on this finding, the 13D Activist Fund specifically seeks to take positions in activist targets from a variety of managers, targeting “20 to 40” holdings. For purposes of comparison, Icahn’s most recent 13F only included a total of 19 positions, and some of these were in smaller-cap stocks (the 13D Activist Fund targets stocks with market capitalizations of at least $1 billion) or in companies where he was not making activist moves.

As a result, by construction its portfolio should incorporate ideas from several activists rather than mimicking any particular fund’s portfolio. The fund managers acknowledge that there is little fundamental analysis involved in their strategy; they prefer to defer on that point and analyze the activist investor’s record directly in determining the likelihood of positive returns.

To do this, they analyze both the overall track record of an activist as well as his success in a particular industry or sector; activists who have historically struggled in tech investments might be ignored if they file a 13D on a tech stock. They also evaluate the activist’s plans for creating change at the company. Different activist techniques might be judged more or less likely to succeed.

Recent data

Its most recent publicly disclosed data shows that the 13D Activist Fund’s three largest holdings were Jack in the Box Inc. (NASDAQ:JACK), where Blue Harbour Group has been engaged in an activist strategy for about three years; Valeant Pharmaceuticals Intl Inc (NYSE:VRX), one of the top holdings of Jeffrey Ubben’s ValueAct Capital, and Canadian Pacific Railway Limited (USA) (NYSE:CP), which has more than doubled in the last two years as Ackman has succeeded in transforming the railroad.

Motorola Solutions Inc (NYSE:MSI), another ValueAct holding, and Ackman favorite BEAM Inc (NYSE:BEAM) rounded out the fund’s top five picks. Looking at the rest of its top holdings, it appears that other activists the fund tracks include billionaire Paul Singer’s Elliott Management, Keith Meister’s Corvex Capital, and Richard McGuire’s Marcato Capital Management.

Final thoughts

Given the combination of the fund’s performance and the academic research supporting the concept of imitating activists, the basic concept involved seems to be a good one particularly for investors who are looking for assets with a low correlation to the overall market.

The question is which of the following would be the best way for an interested investor to participate: buy into the fund and pay its fees (likely the only way for most investors to access the entire portfolio of activist opportunities), watch for its public reports and directly buy some of the stocks the managers choose (which has a considerable delay), or follow 13Ds oneself and directly research these for attractive single-stock investments.

Disclosure: I own no shares of any stocks mentioned in this article.

Insiders Are Crazy About These High-Yield Stocks

By Guest Author Insider Monkey. According to economic theory, company insiders should avoid buying stock and in fact should generally tend towards selling shares (and diversifying their wealth) unless they are confident in the company’s prospects. Insider purchases should therefore signal this confidence, and in fact studies generally show a small outperformance effect for stocks bought by insiders (read our analysis of studies on insider trading). We track insider purchases and like to take a brief look at those where the purchase is large enough to be significant to see if the company might be a good buy.

Read on for our quick take on five high yield stocks which at least one insider has bought recently:

AT&T

An AT&T [T] Board member’s trust bought 9,000 shares of the company’s stock in late July. At current prices and dividend levels, AT&T pays an annual yield of 5%; in addition, the telecom giant is quite defensive with a beta of only 0.2. The company’s financials are stable as well, with growth in wireless being canceled out by a decline in the wireline segment resulting in total revenue and earnings only changing by 1-2% compared to a year ago.

We also track hedge fund activity, including through quarterly 13F filings; our research shows that the most popular small cap stocks among hedge funds outperform the S&P 500 by an average of 18 percentage points per year (learn more about our small cap strategy), and our own small cap portfolio based on hedge funds’ top picks has seen an excess return of 33% in the last 11 months. According to our database, Phil Gross and Robert Atchinson owned nearly 7 million shares of AT&T at the end of March.

Freeport-McMoRan

Another large company where an insider has been indirectly buying is commodities producer Freeport-McMoRan Copper & Gold [FCX]. With the stock down 13% in the last year against a market which has returned over 20%, the current dividend yield is now 4.3%. One contributing factor to the stock’s decline has been market disapproval over the company’s recent acquisition of two oil and gas companies; in addition to normal integration risk, it’s possible that this diversification could weaken management’s focus. Paulson & Co., managed by billionaire John Paulson, reported a position of 9 million shares at the end of Q1. George Soros, Ray Dalio, and Leon Cooperman were also bullish about the stock.

Philip Morris

One of the members of Philip Morris [PM]’s Board of Directors bought 1,000 shares of stock on July 23rd at prices around $89 per share. The $150 billion market cap global cigarette company offers a 3.8% dividend yield- lower than many other cigarette companies, on the theory that there are still a good deal of growth opportunities in international markets. With growth being weak in many countries around the world, Philip Morris’s revenue and earnings decreased modestly last quarter compared to the second quarter of 2012. Billionaire Ken Griffin is among PM shareholders.

Digital Realty Trust

An insider, as well as his children, recently bought shares of technology use-focused real estate investment trust Digital Realty Trust [DLR]. Because REITs receive favorable tax treatment as long as they distribute a large share of taxable income to shareholders, they often pay high dividend yields. Digital Realty Trust’s annual yield is 5.7%, and unlike many REITs it has been consistently increasing its dividend for years even through the financial crisis. We’d note that the stock is down 21% year to date following a steep drop in July, but investors who are not already too exposed to REITs may want to consider it.

Hersha Hospitality Trust

Another real estate investment trust which we’ve recorded an insider buying recently is Hersha Hospitality Trust [HT]. Hersha, an owner of hotel properties, did not perform well during the financial crisis and recession and so its dividend still has not recovered to its levels from the middle of 2008. The yield is still somewhat high, at 4.3%, but given the other opportunities available in REITs it might not be worth the risk. Ken Heebner’s Capital Growth Management initiated a position of 6.3 million shares in Hersha between January and March.

Disclosure By Author: none

The Truth About Hedge Funds

It’s time to set the record straight. Many members of the media have reacted negatively to the development that hedge funds will be allowed to advertise to the general public. A number of outlets have been critical of the hedge fund industry for some time due to the fact that some money managers have been accused of unethical behavior like insider trading, as well as the fact that many billionaires (about 40 to be exact) are hedge fund managers, somehow asserting that this means they do not need—or deserve—any additional clients.

In a gift to these critics, the relaxation of advertising rules comes as the S&P 500 ETF [SPY] has risen almost 30% over the last two years, meaning that if a particular hedge fund has only returned 10% per year over this period, it has underperformed the market. This cut-and-dry comparison makes it easy to poo-poo on the industry at large, but it’s frankly not that simple.

Yes, hedge funds indices have, in fact, underperformed the S&P 500 index recently, but that’s assuming that these indices contain the entire “universe” of 8,000-plus hedge funds in existence today. In reality, there are plenty of upper-tier funds that do not report their returns to hedge fund data providers. In addition, most of the hedge funds do not invest in plain vanilla stocks and comparing their returns to the S&P 500 index is absolutely absurd.

Many members of the financial media claim that hedge funds can’t pick winning stocks. They acknowledge that there are some hedge fund managers who can beat the market, but no one can pick “good” hedge fund managers before they prove themselves. Based on these two assumptions they conclude that investors should stay away from hedge funds. We are going to present evidence to the contrary. We will also explain why hedge funds invest in Apple [AAPL] and Google [GOOG] in droves.

Do Hedge Funds Know How to Pick Good Stocks?

Absolutely, yes.

We have a database of all 13F holdings for 92% of hedge funds between 1999 and 2009. According to our calculations hedge funds’ stock picks with market values between $1 billion and $10 billion outperformed the S&P 500 index by 10.3 percentage points per year (to be exact 82 basis points per month) during this 10 year period. Hedge funds’ large cap stock picks outperformed the market by 18 basis points per month or about 2.2 percentage points per year.

That’s not the all story though.

From a consensus standpoint, there is a specific range of small and mid-cap stocks that gives piggyback investors the potential to outperform the market indices by a huge margin. The most popular 15 small-cap stocks among hedge funds outperformed the market by 18 percentage points during this time period.

Wait, we know what you are thinking. These results only show that hedge funds were good between 1999 and 2009. How about the past 12 months?

We knew this question would be coming a year ago. So, we launched a quarterly newsletter that picks the 15 most popular small-cap stocks among hedge funds in real time. We launched this newsletter at the end of August 2012 and have been sharing our performance since. So how did these 15 most popular small-cap stocks perform since August 2012?

Much better. Our picks returned 54.5% through July 30^th, vs. a 22.1% gain for the SPY (see the details here). This can’t be explained by coincidence. Hedge funds are amazing at picking winners. We have the historical data and we have been testing this in real time. Our data confirms this fact.

Can We Pick Successful Hedge Fund Managers?

The second myth spelled out by uninformed financial journalists is that even though there are good hedge funds, there is no way that we can spot them before the fact. For every David Einhorn out there, there are dozens of unsuccessful hedge fund managers and we couldn’t know which one is which 15 years ago.

You know what? This is why hedge fund advertising will be beneficial for investors. Investors will have access to more information about hedge funds, their stock picks, their performance, interviews that shed a light on their character, and they will do a much better job at picking good hedge fund managers.

Picking good hedge fund managers is actually much easier than you think. If, on the whole, hedge funds weren’t good at picking stocks (i.e. their performance was purely random), then it would be impossible to pick good managers. However, once you know that it is possible to be good at selecting stocks, you will know that it is also possible to be skilled at finding quality hedge fund managers.

So far, Insider Monkey has endorsed one hedge fund manager based on the performance of his past stock picks: Michael Castor of Sio Capital. We even called him “the next David Einhorn” at the end of March. We also shared his top stock picks in the same article. Do you think his picks underperformed the market? Do you think his picks barely beat the market? Or do you think his picks absolutely crushed the S&P 500 index?  

Castor’s first pick, Cardinal Health [s:CAH], returned 21.5% since we published that article. Castor’s second pick, NPS Pharmaceuticals [s:NPSP], gained 76.5%. The S&P 500 ETF’s 8.2% return during the same period was also worse than Castor’s third pick’s - Anacor Pharmaceuticals [s:ANAC] - 15% gain. Castor’s three picks averaged 37.7% in four months.

We then checked in on Castor again in our June newsletter, where he discussed Rockwell Medical [RMTI] and Mazor Robotics [MZOR]. Since publishing that newsletter on June 10th, Rockwell is up 21.7% and Mazor has risen 17.2%. The S&P 500 index gained only 2.8% during the same time period. We don’t think every single one of Castor’s picks can beat the market, but if you can beat the market 60% of the time, you will have higher returns than billionaire Warren Buffett.

Are Hedge Funds Perfect?

Here is the truth about hedge funds. Their picks beat the market on the average and their small-cap picks have absolutely crushed the market indices. However, their large cap stock picks only beat the market by a couple of percentage points a year.

Hedge funds’ biggest sin is asset hoarding. There aren’t enough small and mid-cap investment ideas for all hedge funds. They have so much capital under management that they have to invest in large cap stocks such as Apple and Google. The problem is that they usually charge 2% of assets and 20% of profits, and these fees are generally higher than the excess return they generate by picking good stocks.

Hedge funds are taking advantage of investors not because they aren’t good at stock picking, but because investors don’t ask for their money back when hedge funds get too big. There are three simple solutions to this problem.

First, investors shouldn’t pay anything for hedge funds’ beta exposure. Second, investors shouldn’t invest in hedge funds that focus on large-cap stocks (or pay ONLY a management fee of at most 2%). The best way of doing that is investing in small and talented hedge funds like Sio Capital. Third, investors can do what we do: they can invest in hedge funds’ best stock picks without paying them a single dime. Our picks have outperformed the market by more than 30 percentage points. I haven’t heard of a lot of hedge funds that have done that over the last year.

Conclusion

Hedge funds aren’t that complicated. They are amazing at picking small-cap stocks and they are good at picking large cap stocks. It is also possible to spot great hedge fund managers by analyzing their historical performance. The problem is hedge funds are asset hoarders and they charge exorbitant fees. These fees are justifiable if they were only investing in small-cap stocks. Unfortunately they aren’t and this isn’t their fault. It is up to the investors to force hedge funds to invest in smaller-cap stocks, or to yank their money from hedge funds and do it by themselves. It is as simple as that.

Disclosure: none