By: Jake Mann
It is a common misconception that hedge funds cannot outperform the market. At Insider Monkey, we've found that, historically, the best picks of the best hedgies can trump the indices; you just have to know where to look. Our small-cap strategy beat the market by 18% a year for more than a decade, and our Billionaire Hedge Fund Index (made in collaboration with MarketWatch) has dominated as well. This article explains how this is possible given that hedge funds have been underperforming the market, but the point is this: retail investors should pay attention to the smart money.
With that being said, it's important to take a fund-by-fund look at each of the 450-plus hedge funds we track, and one great manager to monitor is Philippe Laffont of Coatue Management. Since he established Coatue in 1999, Laffont and his team have generated a net annualized return of more than 14%-they were up 17.6% (net) in 2012 alone. Using Laffont and Coatue's fourth quarter 13F filing with the SEC, we can determine how they were preparing their equity portfolio for 2013 (see their full profile here). Let's take a look at their top five stock picks.
Equinix (EQIX) may fly under the mainstream investor's radar, but it shouldn't. According to our records, 55 of the hedge funds we track were bullish on the data center solutions company, more than traditional smart money stalwarts like Exxon (XOM) and Wal-Mart (WMT). Equinix has experienced quite a rebirth post-dotcom bubble, with most of this expansion coming inorganically.
The company has publicly stated a goal of $3 billion in total revenue by 2015, which would imply an annual growth rate of almost 20% over the next three years. The sell-side expects EPS growth to fall in line with this figure, placing Equinix 2nd highest of its 20 industry peers. Now, there's not much here to be excited about from a valuation standpoint, but this is a momentum play, through and through, and the smart money's conviction is encouraging.
Media giants Virgin Media (VMED), Time Warner (TWX) and Liberty Global (LBTYA) sit at the No.'s 2, 3 and 4 spots in Laffont and Coatue's equity portfolio, and each has returned a pretty penny in 2013. In early February, it was announced that Liberty Global would acquire Virgin Media for an estimated price of about $47.87 per VMED share. After returning more than 15% since this deal was announced, Virgin is still trading at a 6-7% discount to this proposed price.
Liberty Global, meanwhile, has seen its shares rise by 3% year-to-date, and Wall Street's average price target represents about a 21% upside from last week's closing price of $64.86 a share. Like Equinix, this stock isn't particularly cheap at the moment; its growth prospects are expected to drive appreciation. Analysts' average estimates forecast EPS expansion in excess of 50% next year, and a PEG of 1.0 indicates Mr. Market is fairly valuing these prospects.
Time Warner, on the other hand, looks a bit more like a value play conventionally speaking, as its shares trade at a mere 12.5 times forward earnings and a 26% discount to its industry's average price-to-book multiple. The diversified media company has beaten the Street's earnings estimates in four of the past five quarters, and it also pays a healthy 2.2% dividend yield. According to Morningstar, Time Warner's cable networks are responsible for nearly three-fourths of its overall cash flow, which includes HBO, TBS, Cartoon Network, and CNN, among others. The company's massive online footprint is also a key strength, and its improvement in the sports arena-most notably with last year's acquisition of Bleacher Report-is a boon to advertising revenues.
Apple (AAPL), lastly, rounds out Laffont and Coatue's top five, and saw its position cut in half last quarter. This was a big move for the hedge fund manager, who had held the tech giant as his No. 1 holding since at least the fourth quarter of 2010 (when we began tracking his fund). Shares of Apple lost more than 20% in Q4 of last year, and are down another 15.3% year-to-date.
It's obvious that at current levels, the company is cheap; a PEG near 0.5 and a forward P/E below 9.0x are clear indicators of its attractiveness to value-seeking investors. Moreover, Apple's growth prospects, while lower than they have been in the past, still compare favorably to competitors. The sell-side's EPS forecast predicts annual growth of about 19% a year through 2017; this places Apple 3rd out of the 74 S&P 500-listed tech companies.
Obviously, dividend bulls are hoping that David Einhorn's "iPref" proposal does gain some traction at the company's annual shareholder meeting later this month. With results like this, it's important to pay attention to the smart money's sentiment at all times.