Did Hedge Funds Make The Right Call On Alliance Data Systems Corporation (ADS) ?

How do you pick the next stock to invest in? One way would be to spend days of research browsing through thousands of publicly traded companies. However, an easier way is to look at the stocks that smart money investors are collectively bullish on. Hedge funds and other institutional investors usually invest large amounts of capital and have to conduct due diligence while choosing their next pick. They don’t always get it right, but, on average, their stock picks historically generated strong returns after adjusting for known risk factors. With this in mind, let’s take a look at the recent hedge fund activity surrounding Alliance Data Systems Corporation (NYSE:ADS) and determine whether hedge funds had an edge regarding this stock.

Is Alliance Data Systems Corporation (NYSE:ADS) a bargain? Investors who are in the know were taking a pessimistic view. The number of long hedge fund positions shrunk by 15 lately. Our calculations also showed that ADS isn’t among the 30 most popular stocks among hedge funds (click for Q1 rankings and see the video for a quick look at the top 5 stocks). ADS was in 30 hedge funds’ portfolios at the end of March. There were 45 hedge funds in our database with ADS positions at the end of the previous quarter.

Video: Watch our video about the top 5 most popular hedge fund stocks.

So, why do we pay attention to hedge fund sentiment before making any investment decisions? Our research has shown that hedge funds’ small-cap stock picks managed to beat the market by double digits annually between 1999 and 2016, but the margin of outperformance has been declining in recent years. Nevertheless, we were still able to identify in advance a select group of hedge fund holdings that outperformed the S&P 500 ETFs by more than 58 percentage points since March 2017 (see the details here). We were also able to identify in advance a select group of hedge fund holdings that underperformed the market by 10 percentage points annually between 2006 and 2017. Interestingly the margin of underperformance of these stocks has been increasing in recent years. Investors who are long the market and short these stocks would have returned more than 27% annually between 2015 and 2017. We have been tracking and sharing the list of these stocks since February 2017 in our quarterly newsletter. Even if you aren’t comfortable with shorting stocks, you should at least avoid initiating long positions in stocks that are in our short portfolio.

At Insider Monkey we scour multiple sources to uncover the next great investment idea. We read hedge fund investor letters and listen to stock pitches at hedge fund conferences. Hedge fund sentiment towards Tesla reached its all time high at the end of 2019 and Tesla shares more than tripled this year. We are trying to identify other EV revolution winners, so we are checking out this tiny lithium stock. Now let’s go over the recent hedge fund action regarding Alliance Data Systems Corporation (NYSE:ADS).

What does smart money think about Alliance Data Systems Corporation (NYSE:ADS)?

At the end of the first quarter, a total of 30 of the hedge funds tracked by Insider Monkey were bullish on this stock, a change of -33% from the fourth quarter of 2019. On the other hand, there were a total of 38 hedge funds with a bullish position in ADS a year ago. With the smart money’s capital changing hands, there exists a select group of key hedge fund managers who were adding to their holdings meaningfully (or already accumulated large positions).

When looking at the institutional investors followed by Insider Monkey, Point72 Asset Management, managed by Steve Cohen, holds the number one position in Alliance Data Systems Corporation (NYSE:ADS). Point72 Asset Management has a $46.7 million position in the stock, comprising 0.4% of its 13F portfolio. The second most bullish fund manager is Lyrical Asset Management, led by Andrew Wellington and Jeff Keswin, holding a $45.9 million position; 1.1% of its 13F portfolio is allocated to the stock. Other hedge funds and institutional investors that are bullish comprise Ken Griffin’s Citadel Investment Group, Allan Mecham’s Arlington Value Capital and D. E. Shaw’s D E Shaw. In terms of the portfolio weights assigned to each position Pacifica Capital Investments allocated the biggest weight to Alliance Data Systems Corporation (NYSE:ADS), around 3.76% of its 13F portfolio. Arlington Value Capital is also relatively very bullish on the stock, setting aside 3.45 percent of its 13F equity portfolio to ADS.

Seeing as Alliance Data Systems Corporation (NYSE:ADS) has witnessed declining sentiment from the smart money, we can see that there exists a select few funds who sold off their positions entirely heading into Q4. At the top of the heap, Ahmet Okumus’s Okumus Fund Management dropped the largest investment of all the hedgies followed by Insider Monkey, totaling close to $153 million in stock, and Ravi Chopra’s Azora Capital was right behind this move, as the fund cut about $62.9 million worth. These bearish behaviors are interesting, as aggregate hedge fund interest was cut by 15 funds heading into Q4.

Let’s also examine hedge fund activity in other stocks similar to Alliance Data Systems Corporation (NYSE:ADS). We will take a look at Plexus Corp. (NASDAQ:PLXS), Turning Point Therapeutics, Inc. (NASDAQ:TPTX), PriceSmart, Inc. (NASDAQ:PSMT), and Ping Identity Holding Corp. (NYSE:PING). This group of stocks’ market valuations are similar to ADS’s market valuation.

View table here if you experience formatting issues.

As you can see these stocks had an average of 14.25 hedge funds with bullish positions and the average amount invested in these stocks was $128 million. That figure was $246 million in ADS’s case. Turning Point Therapeutics, Inc. (NASDAQ:TPTX) is the most popular stock in this table. On the other hand PriceSmart, Inc. (NASDAQ:PSMT) is the least popular one with only 11 bullish hedge fund positions. Compared to these stocks Alliance Data Systems Corporation (NYSE:ADS) is more popular among hedge funds. Our calculations showed that top 10 most popular stocks among hedge funds returned 41.4% in 2019 and outperformed the S&P 500 ETF (SPY) by 10.1 percentage points. These stocks returned 12.3% in 2020 through June 30th but still managed to beat the market by 15.5 percentage points. Hedge funds were also right about betting on ADS as the stock returned 34.8% in Q2 and outperformed the market by an even larger margin. Hedge funds were clearly right about piling into this stock relative to other stocks with similar market capitalizations.

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