By Serkan Unal
Jim Simons, a billionaire with a net worth of $11 billion, is currently a non-executive Chairman at Renaissance Technologies (RenTech), an investment firm he founded in 1982. With more than $32 billion in assets under management, Simons' RenTech is considered the largest and one of the most profitable U.S. hedge funds. It has returned as much as 30% or more per year in the last two years. One of its flagship funds, the Medallion Fund has returned 35% per year, on average, since 1989. As regards its investment style, RenTech applies computer-based models to isolate opportunities created due to market inefficiencies and to make predictions about future price moves. Participating in Rentech's high return funds is quite costly: The fund assesses a management fee of 5% and a profit participation of 44%, compared with industry standards of 2% and 20%, respectively.
RenTech has just filed a new 13-F with the Securities and Exchange Commission, showing the hedge fund management company's portfolio at the end of the third quarter. Rentech's holdings remain well diversified across industry sectors, represented by high-quality stocks with high return on equity and attractive dividend yields. Here are Rentech's five largest holdings that yield more than the S&P 500 index and the 10-year Treasuries:
Microsoft (MSFT) is the single largest stake in RenTech's third-quarter portfolio, valued at more than $478 million. Microsoft is also the second largest technology company by market capitalization. Its current dividend yield is 3.5% and its payout ratio is 50%. The company's main competitors Apple Inc. (AAPL) and Hewlett-Packard Company (HPQ) are yielding 2.0% and 4.0%, respectively, while rival Google (GOOG) does not pay any dividends. The company has been generating substantial cash flow and is likely to accelerate growth in top and bottom lines from the introduction of new products, such as touchscreen-ready Windows 8 and a tablet PC, the Surface. In response to persistent weakness in the PC market, the company has focused on growth in the higher-margin enterprise business. Analysts expect the company's EPS to expand at an average rate of nearly 10% per year for the next five years. For the reference, over the past five years, Microsoft's EPS grew at an average annual rate of 7.0%, while dividends expanded at a rate of 15% per year. The stock boasts a high free cash flow yield of 10% and a ROE of 25%. It has a forward P/E of 8.6, trading at a deep discount to the software industry and the technology sector. Its rivals Apple and Google have forward P/Es of 10.7 and 14.8, respectively. Value investors Donald Yacktman and Seth Klarman are bullish about the company.
Eli Lilly (LLY) is the second-largest holding in RenTech's portfolio, valued at almost $432 million. Eli Lilly is a pharmaceutical company with $51-billion in market capitalization. While the company's EPS expanded by nearly 10% per year over the past five years, its dividends grew at an average rate of about 3.0% per year. The stock is currently yielding 4.3% on a payout ratio of 53%. The company's competitors GlaxoSmithKline (GSK), Pfizer (PFE), and Sanofi SA (SNY) are yielding 5.5%, 3.7%, and 4.0%, respectively. Like other major pharmaceutical companies, Eli Lilly is facing lower revenues due to patent expirations, including the expiration of its U.S. patent for the blockbuster antidepressant Cymbalta. That is why its EPS is expected to contract at a rate of nearly 5% per year for the next five years. Still, the company has a strong balance sheet with low debt. It also has a promising pipeline of new drugs under development, especially in the fields of rheumatology, oncology, and neurosciences (e.g. drug solanezumab for treatment of Alzheimer's disease). Recently, the company reported positive results from a Phase III trial of drug ramucirumab in patients with metastatic gastric cancer. Eli Lilly's stock has a free cash flow yield of 4.1% and ROE of 26.5%. In terms of valuation, the stock has a forward P/E of 12.6, slightly higher than the pharmaceutical industry's at 11.7 and Pfizer's at 10.9. Among fund managers, Andreas Halvorsen from Viking Global is also a major investor in the stock (see this almost billionaire hedge funder's stock picks).
Intel Corp. (INTC) is the third-largest stake in RenTech's third-quarter portfolio. It was worth almost $424 million at the end of the quarter. This world's largest chip maker with a market cap of $100 billion is paying a dividend yield of 4.5% on a payout ratio of 39%. Its rival Texas Instruments Inc. (TXN) is yielding 2.9%, while competitor Advanced Micro Devices (AMD) does not pay any dividends. Over the past five years, Intel's EPS and dividends grew at average annual rates of 22.8% and 14%, respectively. While the weak PC market has hurt Intel's financial performance, the outlook is not as bleak as some would expect. The rate of EPS growth is expected to slow down to an average rate of 10.6% per year for the next five years. The company has a free cash flow yield of 3.2% and a ROE of 25%. In terms of valuation, Intel has an attractive forward P/E of 11.0, trading at a discount to its respective industry with a forward P/E of 14.3, on average, and Texas Instruments' with the ratio of 17.5. Considering all of the above, Intel appears to be a good value play.
Merck & Co. (MRK) is the fourth-largest stake in RenTech's portfolio, valued at close to $423 million at the end of the previous quarter. Merck & Co. is one of the oldest pharmaceutical companies in the world. It has paid a dividend since 1969. The stock is currently yielding 3.9% on a payout ratio of 77%. Merck & Co.'s competitors Pfizer and Novartis AG (NVS) are yielding 3.7% and 4.2%, respectively. Over the past five years, Merck & Co.'s EPS was flat, while dividends grew at a meager average rate of 2.0% per year. EPS is forecast to expand at an average annual rate of close to 4.0% for the next five years. The company is in a somewhat better position than competitors in terms of patent expirations. While it recently lost a patent protection on asthma treatment Singulair, Merck & Co. has a strong pipeline of drugs, including hot-selling diabetes medications. It also has a good pipeline of trial drugs, with a particularly promising treatment for osteoporosis (e.g. odanacatib). The stock has a ROE of 12%. Its forward P/E is 11.9, almost on par with the ratios of the pharmaceutical industry and Novartis AG, but slightly above Pfizer's forward P/E of 10.9. PointState Capital and Adage Capital are top hedge funds buying this pharmaceutical stock.
McDonald's Corporation (MCD) is the fifth-largest position in RenTech's portfolio. It was valued at about $380 million at the end of the third quarter. This world's largest chain of fast food restaurants is paying a dividend yield of 3.7%. Its payout ratio is 58%. For the reference, its peers Darden Restaurants (DRI) and YUM Brands (YUM) are yielding 4.0% and 1.9%, respectively. Burger King Worldwide (BKW) is paying a dividend yielding 1.0%. Over the past five years, McDonald's Corporation's EPS and dividends expanded at average rates of 18.0% and 13.3% per year, respectively. Analysts forecast that the company's EPS will grow by 8.5% per year for the next five years. The company reported lower same-store sales in October, with weakness present in all geographical segments. Weak labor markets around the world, especially in Europe, are hurting discretionary spending, which bodes poorly for the restaurant businesses, including McDonald's. However, in the long term, given its significant and growing exposure in emerging markets, the company will benefit from growth in incomes in those markets. The stock has a free cash flow yield of 1.3% and ROE of 40%. McDonald's has a forward P/E of 14.9, trading at a discount to its respective industry. Its peers Burger King Worldwide and YUM Brands have forward P/Es of 22.8 and 19.7, respectively. Billionaire Ken Fisher and fund manager Phill Gross (Adage Capital) are major hedge fund investors in the stock (see Ken Fisher's top stock picks).
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.