By Matt Doiron
Several weeks after the end of each quarter, hedge funds and other major investors are required to file 13Fs with the SEC to disclose many of their long equity positions in U.S. stocks as of the end of the quarter. We have found that by tracking and processing these filings in our database we can glean a good deal of information from them, including potential investment strategies. We've actually found that the most popular small cap stocks among hedge funds earn an average excess return of 18 percentage points per year (check out the details behind our strategy here). Eleven months ago we began publishing a quarterly newsletter to share each quarter's picks; this portfolio has outperformed the S&P 500 by 33 percentage points and the Russell 2000 by 25 percentage points since that time.
We can also go through our database and pick out hedge funds' favorite stocks in specific industries or sectors. When we looked up the data on hedge funds' favorite restaurant stocks, we found that once again they tended towards quick service rather than full service restaurants. Here are the five stocks which the largest number of filers in our database owned at the end of June:
Starbucks (SBUX) led the list with 51 funds and other major investors reporting a position in the coffee shop chain. Various growth initiatives drove revenue up 13% in the second quarter of 2013 versus a year earlier, despite the already large size of the company, and with margins improving net income rose by more than 20%. Markets have priced quite a bit of future growth into the stock, with a trailing P/E of 34, and even given recent performance that does seem aggressive. Renaissance Technologies, founded by billionaire Jim Simons, increased its stake in Starbucks last quarter to a total of 1.1 million shares (see Renaissance's favorite stocks).
Despite its larger size by market cap ($96 billion versus $53 billion for Starbucks), McDonald's (MCD) was forced to settle for the #2 spot on our list. While its value focus makes McDonald's a popular defensive pick- the stock's beta is 0.2, and at current prices its dividend yield is 3.2%- recent growth numbers have been fairly modest. The stock features trailing and forward earnings multiples of 18 and 16 respectively, and we'd generally want to see higher growth rates to consider McDonald's a good buy at those levels at least from a value perspective.
Yum Brands (YUM) has been having problems with its Chinese operations recently (China is a key geography for the company, responsible for a large share of operating income), and this contributed to a 15% decrease in profits in its most recent quarter compared to a year earlier. Investors generally expect Yum Brands to recover, and so it is valued at a premium to McDonald's at 23 times trailing earnings. However, Wall Street analysts actually seem less bullish than buy-siders with only limited improvement in EPs expected in 2014. 32 filers in our database were long the stock at the end of Q2.
On net a few hedge funds bought into Chipotle Mexican Grill (CMG) between April and June; billionaire Israel Englander's Millennium Management increased its stake in the burrito chain to a total of about 110,000 shares (check out Englander's stock picks). Bulls love Chipotle's growth opportunities, and have bid up the stock price to a trailing P/E of more than 40. However, we're a bit concerned by the recent financial performance: revenue numbers have been strong, but thanks to falling margins net income grew only 7% last quarter compared to the second quarter of 2012. That figure seems out of line with the stock's valuation.
Finishing up our list is Domino's Pizza (DPZ), which appears to have successfully reinvented its brand through some combination of improved product and aggressive marketing. It is now seeing double-digit growth rates on both top and bottom lines, and the stock is up nearly 70% in the last year and more than double its levels from two years ago. As with some of the other companies on this list the market consensus is for high growth over the next several years, leading to some high earnings multiples; for example, the forward P/E is 22.