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Following the Money Trail: Where are Hedge Funds Investing?

For years, investors have chased the latest tech darlings, throwing money at overvalued companies based on hype and empty promises. At Insider Monkey we do things a little bit different. We focus our attention on not stock promoters but seasoned hedge fund managers and shrewd corporate insiders. We pay attention when informed executives and smart hedge fund managers are putting their money where their mouth is, buying up shares!

It isn't always straightforward to identify the smart insiders and hedge fund managers though. Periodically we go back in time and take a look at the predictions of hedge fund managers and evaluate the accuracy of these predictions. That's one of the ways we form an idea about the skill level of a particular hedge fund manager.

In this article, we will be exploring ten stocks that hedge funds were talking about 3-4 months ago. The S&P 500 Index ETF (SPY) returned about 10% over this period.

Three months ago we set aside several quarterly commentaries of hedge fund houses to select the stocks these hedge funds were bullish on. Virtu Financial (VIRT), PayPal Holdings, Inc. (PYPL), Jazz Pharmaceuticals (JAZZ), and Waters Corporation (NYSE:WAT) are some of the stocks listed in the article. We are going present these stocks based on their 2024 performance (from worst performing to best performing):

10. Jazz Pharmaceuticals plc (NASDAQ:JAZZ)

Number of hedge fund holdings at the end of Q3:40

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2024 Return: -4.4%

Jazz Pharmaceuticals plc (NASDAQ:JAZZ) is an Ireland based biopharmaceutical company. Pricing power, strong success track record, innovation and attractive valuation increases the popularity of Jazz Pharmaceuticals plc (NASDAQ:JAZZ) among investors. Jazz Pharmaceuticals plc (NASDAQ:JAZZ), incorporated in 2003, is headquartered in Dublin, Ireland and has a market capitalization of $8.38 billion.

Aristotle Capital Global Equity Strategy made the following comment about Jazz Pharmaceuticals plc (NASDAQ:JAZZ) in its Q3 2023 investor letter:

"During the quarter, we sold our position in Magna International and invested in a new position, Jazz Pharmaceuticals plc (NASDAQ:JAZZ). Founded in 2003, Jazz Pharmaceuticals is a global biopharmaceutical company headquartered in Ireland. The drugmaker’s portfolio of nine approved products focuses on conditions with limited therapeutic treatments in neuroscience (~75% of 2022 revenue) and oncology (~25%).

Jazz’s drug Xyrem was added to its portfolio in 2005 and was approved for use in patients with narcolepsy. The drug’s strong efficacy propelled it to be the standard of care for this incurable sleep condition and has achieved wide adoption for the treatment of excessive daytime sleepiness and cataplexy (episodes of loss of muscle control).

Xyrem’s patent exclusivity ended in January 2023, and authorized generic versions of the product have entered the market. To prepare for the patent cliff, the company developed Xywav, a lower‐sodium version of Xyrem, which is touted for its potentially better heart safety. The drug has received FDA approval for the treatment of narcolepsy and idiopathic hypersomnia and has orphan drug exclusivity through 2027...” (Click here to read the full text)

Jazz Pharmaceuticals PLC’s (NASDAQ:JAZZ) EVP and CFO Philip Johnson bought 12,000 shares of Jazz Pharmaceuticals PLC (NASDAQ:JAZZ) on March 1 at $119.65 per share. The stock closed at $118.85 that day. According to Yahoo Finance, JAZZ is trading at a forward multiple of only 6.3. There is probably something wrong with that estimate (seems too optimistic). We need to take a much closer look at this stock in the upcoming issue of our monthly newsletter and decide whether it is too cheap or the EPS estimates are too optimistic.

 

9. Rover Group, Inc. (NASDAQ:ROVR)

Number of hedge fund holdings at the end of Q3: 21

2024 Return: 1%

Rover Group, Inc. (NASDAQ:ROVR) is an online marketplace to connect pet owners with pet providers who provide services like dog boarding, dog walking, doggy daycare, drop-in visits, grooming, and training. Rover being a rapidly expanding company with a long runway ahead makes it an attractive investment choice. Rover Group, Inc. (NASDAQ:ROVR) is headquartered in Seattle, Washington and has a market capitalization of $1.288 billion.

White Falcon Capital Management made the following comment about Rover Group, Inc. (NASDAQ:ROVR) in its Q3 2023 investor letter:

"Rover Group, Inc. (NASDAQ:ROVR) has surpassed Tech Resources to become a top 5 position in the portfolio. Rover, a pet care marketplace, is a prime example of a business that's poised for success in virtually any economic environment. It reported a set of fantastic earnings due to which its stock gained 50% and has not given up much of that gain in the recent pullback. This is a position that has been in the portfolio since September 2022 but we added to the position as we gained conviction in the thesis.

Operating as a marketplace, Rover earns a "take rate" or a kind of "toll" on every transaction occurring within its platform. In the face of inflation, as pet sitters request higher prices for their services, Rover's revenues naturally grow because its share of the transaction value increases. In addition, Rover is a category disrupter due to which its revenue growth is likely to be much higher than the average stock - it is taking share from friends and family as well as kennels. Finally, networks like Rover get more valuable over time due to which they have to spend less to attract more users on their platform. This results in operating leverage due to which its earnings are poised to grow even faster than revenues.

Rover is expected to produce $230 mn in revenues in 2023. At an average cost per share of $4.25 we bought Rover with a market capitalization of $775 million and an EV of $525 mn. Rover is currently at adj EBITDA margin of 15% and, with scale, should be able to move up to 30% in adj EBITDA margin. At that rate, it should have a ‘look-through’ adj EBITDA of $70 mn in 2023, essentially meaning that we underwrote this investment at 7.3x adj EBITDA. The stock is now ~50% higher than our cost base. However, its fundamentals are improving at an even faster pace. Next year, in 2024, according to consensus estimates, Rover is expected to do $300 mn in revenues. Due to this, Rover is now trading at 10x our estimate of $90 in ‘look-through’ adj EBITDA for 2024. We believe this is a very cheap multiple for a high quality and growing business. In Appendix A to this letter, we detail our thesis on Rover (ROVR)... " (Click here to read the full text)

Rover didn't return much in 2024 because it announced at the end of November 2023 that it agreed to be acquired by a private equity company for $11 per share. Rover shares were trading around $8 a share before the announcement, so White Falcon Capital returned more than 150% by betting on ROVR. We shared White Falcon's investor letter and ROVR thesis on October 16th. ROVR shares were trading at less than $7 at that time. We will keep following the performance of White Falcon Capital's other stock picks to determine whether its ROVR call was just luck or skill.

 

8. Waters Corporation (NYSE:WAT)

Number of hedge fund holdings at the end of Q3: 30

2024 Return: 3.2%

Waters Corporation (NYSE:WAT), founded in 1958, is a specialty measurement company that provides analytical workflow solutions that operates through Waters and TA segments. The company provides analytical workflow solutions for QA/QC to customers in the pharmaceutical, industrial, academic, and government sectors. Consistent track record, strong financial position and attractive valuation make Waters Corporation (NYSE:WAT) an investment choice.

Artisan Mid Cap Value Fund made the following comment about Waters Corporation (NYSE:WAT) in its Q3 2023 investor letter:

"We made one new purchase in Q3: Waters Corporation (NYSE:WAT) Classified in the health care sector, Waters is a specialty measurement company that offers analytical workflow solutions for quality assurance/quality control (QA/QC) to pharma, industrial, academic and government customers. As always, for a new name to enter the portfolio, we require it to meet each of our three margin of safety criteria: attractive business economics, a sound financial condition and an attractive valuation. With regard to Waters, its business economics benefit from high growth visibility given the recurring nature of its portfolio. Moreover, it has industry-leading margins that have been very stable over time, it converts most of its earnings to cash, and its free cash flow margin is ~20%. Waters has a high recurring revenue stream (about 50% of revenues), which includes consumables, services and software, and this also contributes to a stronger financial condition. The balance is instruments, which are driven by replacement, moderate market growth and innovation. Instruments sales are quite sticky because methods for testing are part of regulatory filings, which are difficult and cumbersome to change. The company has a conservative balance sheet. Net leverage (net debt/EBITDA) has risen to 2.3X post its acquisition of Wyatt Technology, but we believe it should de-lever back to its long-run average of 1.0X in a few quarters. We were able to purchase it at an attractive price because the stock de-rated due to concerns about pharma capital spending. Waters is trading close to a trough multiple on EV/EBIT and at a discount to peers."

Artisan Value Fund stated that WAT trades at an attractive valuation. According to Yahoo Finance WAT's forward PE ratio is nearly 29. The company generated $2.97 billion in revenue in 2022 and $2.96 billion in 2023, so we don't see any recent revenue growth either. We disagree with Artisan regarding WAT's valuation. We just shared a profitable AI stock that is growing its revenue and trading at 9 times its forward EPS on our website. There are dozens of other stocks that look more attractive than WAT. What are we missing?

 

7. PayPal Holdings, Inc. (NASDAQ:PYPL)

Number of hedge fund holdings at the end of Q3:78

2024 Return: 5.3%

PayPal Holdings, Inc. (NASDAQ:PYPL) is a technology company that enables digital payments. PayPal Holdings, Inc. (NASDAQ:PYPL) stands in 13th position on Insider Monkey’s 30 Most Popular Stocks Among Hedge Funds list. Customers can send and receive payments using PayPal platform in nearly 200 markets in 150 currencies, withdraw funds to their bank accounts in 56 currencies, and maintain balances in their PayPal accounts in 25 currencies. PayPal Holdings, Inc. (NASDAQ:PYPL), founded in 1998, is headquartered in San Jose, California, and has a market capitalization of $62.764 billion.

Manole Capital Management made the following comment about PayPal Holdings, Inc. (NASDAQ:PYPL) in its Q3 2023 investor letter:

"Speaking of payment trends, it has been 8 years since we published a stock specific note on PayPal Holdings, Inc. (NASDAQ:PYPL). If you click on www.manolecapital.com/research, you can re-read that note from September 2016. In it, we specifically discuss how PayPal could begin to monetize its Venmo asset, following its spinout from eBay.

Here’s a picture we recently took at a retailer’s point-of-sale. While PayPal and Venmo are not yet as universal as Visa and Mastercard, more and more retailers are beginning to accept other brands.

Following some difficult performance of late, we thought it might be helpful to examine what’s going on with PayPal….” (Click here to read the full text)

PayPal is a broken stock that's trying to come back. It used to be a growth stock and it is now trading at the forward PE multiple of a value stock. According to Yahoo Finance PayPal's forward PE multiple is less than 13, and its revenue growth rate is more than 8%. Its main problem seems to be cost control; its cost of revenue grew by more than 17% in 2023.

 

6. Virtu Financial, Inc. (NASDAQ:VIRT)

Number of hedge fund holdings at the end of Q3:16

2024 Return: 5.5%

Virtu Financial, Inc. (NASDAQ:VIRT) is a financial services company that provides liquidity and infrastructure to financial markets. Virtu Financial, Inc. (NASDAQ:VIRT) has excellent investment potential due to its resilient character, well-established setup, and growth prospects. Virtu Financial, Inc. (NASDAQ:VIRT) is headquartered in New York, New York, and has a market capitalization of $3.038 billion.

East 72 made the following comment about Virtu Financial, Inc. (NASDAQ:VIRT) in its Q3 2023 investor letter:

"This month, we detail one of only two listed companies (the other is Flow Traders) whose main business is to operate as a liquidity supplier in financial markets: Virtu Financial, Inc. (NASDAQ:VIRT). Virtu reputedly sees over 9% of US equity volumes per day pass across its desks (well, through its machines) - but is utterly unloved at present. The loathing is partly to do with recent volatile business performance, partly with flawed execution of their capital management strategy, a response to fundamental competitive trends in (stock) exchanges, but most recently with the aggressive stance taken towards the Chair of US SEC, the key regulator, Gary Gensler, and his attempts to “protect” retail investors. The whole industry is happy to embrace certain reforms – but not others. Moreover, Virtu has – to a degree – led with its head, seemingly eliciting a particularly aggressive response. Investors don’t like uncertainty, especially regulatory uncertainty. Herein lies the opportunity, perhaps.

In one guise or other, in January 2024, assuming Dynasty Trust is still holding, I will be into my SEVENTH year of having exposure to Virtu Financial Inc (VIRT), though not necessarily continuously. Given what Virtu does, even allowing for cycles in its earnings, that’s a long time.

Virtu Financial, with an equity market capitalisation at end September 2023 of just overUS$2.8billion and with $1.8billion of long-term debt due in 2029, is the sole listed US based “liquidity provider”. Liquidity providers, or market makers, are a controversial industry of financial market “plumbers” who are receiving extra unwanted and tainted publicity with the release of the movie “Dumb Money” regarding the meme stock explosion of securities like Game Stop and AMC Entertainment in early 2021. The March quarter of that year was Virtu’s second most profitable ever, measured by “daily profit”. The short term “sugar-hit” has provided a longer-term hangover – an SEC enquiry and proposed tighter regulation..." (Click here to read the full text)

We like the business VIRT operates in, however, its revenue growth rate since 2020 isn't appetizing and the stock is trading at a forward PE of nearly 15. The only thing that is attractive about this stock is its nearly 5% dividend yield.

Click to continue reading and see the 5 Stocks Hedge Funds Are Investing In   Suggested Articles:

Disclosure: None. This article is originally published at Insider Monkey.