Best Stocks To Buy In An Overvalued US Stock Market

Sandy Nairn‘s Edinburgh Partners recently filed its 13F with the SEC for the reporting period ending September 30th. Edinburgh Partners is a Scotland-based hedge fund specializing in International, EAFE, Global, European and Emerging Market equities founded by Mr. Nairn in 2003. Prior to founding Edinburgh Partners Sandy Nairn served as the chief investment officer of Scottish Widows Investment Partnership and before that he spent a decade working under investing legend John Templeton at Templeton Investment Management. Although Edinburgh Partners boasts of over $12 billion in assets under management, according to the latest fling its U.S. equity portfolio – which till a few quarters ago was worth $2.4 billion- accounted for only a fraction of that at around $950 million, as of September 30. The primary  reason why Edinburgh Partners  has been cutting its exposure to U.S. equities in the past few quarters was revealed by Mr. Nairn in an interview conducted a few months ago, in which he said:

“On a valuation basis pretty much everywhere looks more attractive than the US at the moment. If equity markets in aggregate are now at fair value or higher, in the US they are well above fair value. Profit margins are already at record levels in the US and merely to keep the market on the same high earnings multiple as today will require margins to move even higher over the next two to three years. This is something we have spent a lot of time on, as it has been a consistent theme both in the individual stocks we research and in aggregate.”

“Our research suggests that this is highly unlikely. Even if you assume that earnings grow no faster than their long term average rate over the next five years, for the US market to rise a further 10% over the next two years the profit margins of US companies will need to rise yet further. That would not only be a record high, but more than twice their long run historical average. We do not think that can or will happen. It is not a credible assumption.”

Even though Mr. Nairn considers the U.S. markets as a whole to be overvalued, according to the  Edinburgh Partners’ 13F filing the firm still owns a considerable stake in several U.S. companies and also initiated a significant stake in two companies during the third quarter. Considering both these facts, it is obvious that Mr. Nairn expects the companies in his portfolio to perform well even if the performance of U.S. market overall disappoints in the short to medium-term. That’s why in this article we will be taking a closer look at some old favorites of Edinburgh Partners and the companies in which it initiated a stake recently.

At Insider Monkey, we track hedge funds’ moves in order to identify actionable patterns and profit from them. Our research has shown that hedge funds’ large-cap stock picks historically underperformed the S&P 500 Total Return Index by an average of seven basis points per month between 1999 and 2012. On the other hand, the 15 most popular small-cap stocks among hedge funds outperformed the S&P 500 Index by an average of 95 basis points per month (read the details here). During the three years since the official launch of our small-cap strategy in August 2012, it has performed just as predicted, returning over 102% and beating the market by more than 53 percentage points. We believe the data is clear: investors will be better off by focusing on small-cap stocks utilizing hedge fund expertise (while avoiding their high fees at the same time) rather than large-cap stocks.

Microsoft Corporation (NASDAQ:MSFT) remained the largest holding of Edinburgh Partners at the end of third quarter even though the firm trimmed its stake in it by 7% during July-September period to slightly above 2.3 million shares worth $102.22 million, as of June 30. Shares of Microsoft Corporation (NASDAQ:MSFT) saw extreme volatility during the third quarter, but ended it nearly flat and are also currently trading flat for the year. In an event earlier this month the company launched a new device ‘Surface Book’ and made updates to some of its existing  products including Lumia phones, Surface Pro and Microsoft Band. Microsoft Corporation (NASDAQ:MSFT) is scheduled to report its third quarter earnings on October 22 and analyst expect it to better the $0.54 EPS it reported for the same quarter last year by declaring EPS of $0.59 for the quarter. Among the hedge funds we track, Jeffrey Ubben’s Valueact Capital was the largest shareholder of Microsoft at the end of second quarter owning over 75 million shares. You can find Ubben’s Microsoft investment thesis – which was shared in a ValueAct investor letter- here.

The story of Edinburgh Partners’ second largest holding, Carnival Corp (NYSE:CCL), during the third quarter was quite similar to the fund’s largest holding. After seeing extreme volatility during the quarter, shares of the cruise vacation company ended the quarter almost flat. Moreover, Edinburgh Partners’ also reduced its stake in the company by 9% during the quarter to slightly more than 2 million shares valued at $100.5 million, at the end of September.  On a year-to-date basis shares of Carnival Corp (NYSE:CCL) are currently trading up by 11%, thanks largely to the more than 20% rally they saw during the May-July period. The company announced today that it will be expanding its presence in China by launching two new cruise brands in the market by 2017. Additionally, it also stated that it is exploring the possibilities of joint ventures with prominent Chinese shipping firms. Ricky Sandler‘s Eminence Capital was one of the hedge funds that increased its stake in Carnival Corp during the second quarter by purchasing an additional 18% shares and bringing its total holding to almost 3.36 million shares.

Moving on, Edinburgh Partners sold around 235,000 shares of networking giant Cisco Systems, Inc.(NASDAQ:CSCO) during the third quarter and brought its total holding in the company down to under 3 million shares. As of September 30, this stake was worth $77.86 million. Shares of Cisco Systems, Inc. (NASDAQ:CSCO) remained range bound for the first seven months of the year, but the severe correction they saw in August caused them to end the third quarter down by nearly 4%.  However, they have recouped most of those losses in the last few days after a series of good news. On October 5, Aquantia Corp., a semiconductor company backed by Cisco Systems, Inc.(NASDAQ:CSCO) received $37 million in its eighth round of funding in an environment where most venture capital firms are shunning semiconductor stocks. This was followed by analysts at Citigroup initiating a coverage on the stock on October 6 with a ‘Buy’ rating and $30 price target. Donald Yacktman‘s Yacktman Asset Management reduced its stake in Cisco consecutively in the first two quarter of the year by 15% and as of June 30 held slightly above 42 million shares.

Harman International Industries Inc./DE/(NYSE:HAR) represented Edinburgh Partners largest new purchase during the third quarter. The fund bought 810,920 shares of the company during the third quarter worth $77.84 million, as of June 30. After gaining almost 40% during the first four months of the year, shares of the acoustics company have had a gradual decline and are currently trading flat for the year.  Harman International Industries Inc./DE/(NYSE:HAR) is scheduled to report its fiscal 2016 first quarter earnings on October 28; analysts are expecting it to report EPS of $1.40, 10% more than the $1.18 EPS it reported for the same quarter last year. On October 7, analysts at Jefferies Group initiated a coverage on the stock with an ‘Underperform’ rating and a %90 price target, which represents a decline of more than 15% from the stock’s current trading price. Hugh Sloane‘s Sloane Robinson Investment Management was one of the hedge funds that initiated a stake in Harman International Industries Inc./DE/(NYSE:HAR) during the second quarter; it owned 71,200 shares of the company, as of June 30.

By purchasing slightly above 1.8 million shares worth $70.58 million at the end of September, Edinburgh Partners initiated a major stake in energy company Apache Corporation (NYSE:APA)  during the third quarter. Shares of Apache Corporation(NYSE:APA) mirrored the decline in oil prices and experienced a continuous fall from mid-April till September. However, they have stabilized in the past few weeks and are currently trading down 28.62% year-to-date. For the second quarter, Apache Corporation(NYSE:APA)  reported a per share loss of $0.37 on revenue of $1.82 billion, compared to analysts expectations of a per share loss of $0.57 on revenue of $1.83 billion. On Septembers 23, analysts at Oppenheimer reiterated their ‘Outperform’ rating on the stock with a price target of $57. Several analysts and experts who cover the stock feel that if oil prices don’t rebound in the near future, it will be detrimental to the financial health of the company. Ken Griffin‘s Citadel Investment Group more than doubled its stake in the company during the second quarter to above 2 million shares.

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