Hedge funds utilize a variety of advanced techniques to generate returns, from leveraged positions to trading derivatives, much of which is beyond the average investor. But as detailed in The Atlantic, these funds haven't exactly been beating the market - on average hedge funds have returned 17% since 01/01/2003, compared to a simple 60-40 equity-bond index fund which would have returned 90% over the same period.
So should investors follow the trends among institutional investors? We decided to compare recent actions of hedge funds with actual negative trends in fundamental and technical data. Are hedge funds, who seem to make poor decisions, making the right call by selling these stocks?
Building the List
We began with a screen for companies with significant net institutional sell-off over the last quarter representing at least 5% of share float. This indicates that institutional investors such as hedge fund managers and mutual fund managers expect these stocks to underperform despite any potential upside.
We then looked for possible fundamental catalysts, which might have lead to the negative sentiment, but which also could deter the average investor who might be considering these companies without paying attention to the actions of institutional investors
First we screened our list for less than encouraging trends in returns, including: Return on Assets (ROA), the result of dividing a company's annual earnings by its total assets and Return on Investments (ROI), a measure of profitability that is calculated by dividing net profits by total assets.
Next we looked for accounting trouble, particularly in accounts receivable. Accounts receivable is the portion of revenue (sales) that has not yet been received. Since there is no guarantee that this money will be recovered, the higher the portion of revenue attributable to accounts receivable, the lower the quality of revenue.
To be specific, we screened our list for stocks seeing slower growth in revenue than accounts receivable year-over-year, as well as accounts receivable comprising a larger portion of current assets over the same time period.
We were left with two companies on our list.
For an interactive version of this chart, click on the image below. Average analyst ratings sourced from Zacks Investment Research.
Do the actions of institutional investors such as hedge funds influence your investments? Or are you more concerned with a company's underlying fundamentals? Use the list below as a starting point for your own analysis.
1. WMS Industries Inc. (WMS-OLD): Engages in the design, manufacture, and distribution of games, video and mechanical reel-spinning gaming machines, and video lottery terminals (VLTs) for the legalized gaming industry worldwide.
- Market cap at $1.4B, most recent closing price at $25.50
- Net institutional sales in the current quarter at -6.0M shares, which represents about 11.11% of the company's float of 54.02M shares.
- TTM Return on Assets at 3.73% vs. an industry average at 10.39%.
- TTM Return on Investments at 4.34% vs. an industry average at 15.18%
- Revenue grew by 1.08% during the most recent quarter ($177.9M vs. $176M y/y). Accounts receivable grew by 20.3% during the same time period ($316.4M vs. $263M y/y). Receivables, as a percentage of current assets, increased from 58.56% to 62.84% during the most recent quarter (comparing 3 months ending 2013-03-31 to 3 months ending 2012-03-31).
WMS has returned 0.91% since 4/29/13, and is one of the worst performing stocks in its industry. The stock is falling behind companies like Multimedia Games Inc. (MGAM), Scientific Games Corporation (SGMS) and Bally Technologies, Inc. (BYI) which returned 27.50%, 13.95% and 5.15%, respectively during the same time period.
Compared to industry peers, the company's EPS growth has not been impressive. EPS grew by -39.59% over the last year, as opposed to MGAM (EPS growth over the last year at 386.53%) BYI (EPS growth over the last year at 25.59%) and International Game Technology (IGT) (EPS growth over the last year at -11.81%).
2. Perry Ellis International Inc. (PERY): Engages in designing, sourcing, marketing, and licensing apparel products for men and women in the United States and internationally.
- Market cap at $309.87M, most recent closing price at $20.20
- Net institutional sales in the current quarter at -624.3K shares, which represents about 5.34% of the company's float of 11.70M shares.
- TTM Return on Assets at 2.23% vs. an industry average at 15.2%.
- TTM Return on Investments at 2.89% vs. an industry average at 20.6%.
- Revenue grew by 12.6% during the most recent quarter ($258.35M vs. $229.45M y/y). Accounts receivable grew by 19.87% during the same time period ($174.48M vs. $145.56M y/y). Receivables, as a percentage of current assets, increased from 36.24% to 39.38% during the most recent quarter (comparing 3 months ending 2013-02-02 to 3 months ending 2012-01-28).
PERY has recorded great gains over the last month, when compared to its closest competitors. The stock returned 15.36% since 4/29/13, better than V.F. Corporation (VFC), Lululemon Athletica Inc. (LULU) and Ralph Lauren Corp. (RL), which returned 5.68%, 4.42% and 0.83%, respectively, during the same holding period.
The company's earnings growth looks weak, with EPS growing by -39.59% over the last year. This is considerably weaker than competitors like PVH Corp. (PVH) (EPS growth over the last year at 55.33%) and LULU (EPS growth over the last year at 46.46%).
*Institutional data sourced from Fidelity, accounting data sourced from Google Finance, all other data sourced from Finviz.