Is DAO A Good Stock To Buy Now?

Most investors tend to think that hedge funds and other asset managers are worthless, as they cannot beat even simple index fund portfolios. In fact, most people expect hedge funds to compete with and outperform the bull market that we have witnessed in recent years. However, hedge funds are generally partially hedged and aim at delivering attractive risk-adjusted returns rather than following the ups and downs of equity markets hoping that they will outperform the broader market. Our research shows that certain hedge funds do have great stock picking skills (and we can identify these hedge funds in advance pretty accurately), so let’s take a glance at the smart money sentiment towards Youdao, Inc. (NYSE:DAO).

Is DAO a good stock to buy now? The smart money was taking a bearish view. The number of bullish hedge fund bets fell by 3 recently. Youdao, Inc. (NYSE:DAO) was in 10 hedge funds’ portfolios at the end of the third quarter of 2020. The all time high for this statistics is 13. Our calculations also showed that DAO isn’t among the 30 most popular stocks among hedge funds (click for Q3 rankings and see the video for a quick look at the top 5 stocks).

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

Hedge funds’ reputation as shrewd investors has been tarnished in the last decade as their hedged returns couldn’t keep up with the unhedged returns of the market indices. 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 66 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.

David Siegel of Two Sigma Advisors

At Insider Monkey we scour multiple sources to uncover the next great investment idea. For example, Federal Reserve has been creating trillions of dollars electronically to keep the interest rates near zero. We believe this will lead to inflation and boost real estate prices. So, we recommended this real estate stock to our monthly premium newsletter subscribers. We go through lists like the 15 best blue chip stocks to pick the best large-cap stocks to buy. Even though we recommend positions in only a tiny fraction of the companies we analyze, we check out as many stocks as we can. We read hedge fund investor letters and listen to stock pitches at hedge fund conferences. You can subscribe to our free daily newsletter on our website. With all of this in mind let’s take a glance at the key hedge fund action surrounding Youdao, Inc. (NYSE:DAO).

Do Hedge Funds Think DAO Is A Good Stock To Buy Now?

At third quarter’s end, a total of 10 of the hedge funds tracked by Insider Monkey were bullish on this stock, a change of -23% from one quarter earlier. By comparison, 0 hedge funds held shares or bullish call options in DAO a year ago. So, let’s see which hedge funds were among the top holders of the stock and which hedge funds were making big moves.

The largest stake in Youdao, Inc. (NYSE:DAO) was held by Orbis Investment Management, which reported holding $242.6 million worth of stock at the end of September. It was followed by Sylebra Capital Management with a $30 million position. Other investors bullish on the company included Renaissance Technologies, Keywise Capital Management, and Millennium Management. In terms of the portfolio weights assigned to each position Orbis Investment Management allocated the biggest weight to Youdao, Inc. (NYSE:DAO), around 1.91% of its 13F portfolio. Keywise Capital Management is also relatively very bullish on the stock, earmarking 1.46 percent of its 13F equity portfolio to DAO.

Since Youdao, Inc. (NYSE:DAO) has faced a decline in interest from the aggregate hedge fund industry, we can see that there lies a certain “tier” of fund managers that decided to sell off their positions entirely heading into Q4. At the top of the heap, Paul Marshall and Ian Wace’s Marshall Wace LLP sold off the biggest stake of the “upper crust” of funds monitored by Insider Monkey, valued at an estimated $2 million in stock, and Ken Griffin’s Citadel Investment Group was right behind this move, as the fund sold off about $0.7 million worth. These transactions are interesting, as aggregate hedge fund interest was cut by 3 funds heading into Q4.

Let’s also examine hedge fund activity in other stocks similar to Youdao, Inc. (NYSE:DAO). These stocks are Crocs, Inc. (NASDAQ:CROX), Immunovant, Inc. (NASDAQ:IMVT), BMC Stock Holdings, Inc. (NASDAQ:BMCH), Momo Inc (NASDAQ:MOMO), Digital Turbine Inc (NASDAQ:APPS), Univar Solutions Inc (NYSE:UNVR), and EnerSys (NYSE:ENS). This group of stocks’ market valuations are closest to DAO’s market valuation.

View table here if you experience formatting issues.

As you can see these stocks had an average of 28.6 hedge funds with bullish positions and the average amount invested in these stocks was $490 million. That figure was $291 million in DAO’s case. Crocs, Inc. (NASDAQ:CROX) is the most popular stock in this table. On the other hand EnerSys (NYSE:ENS) is the least popular one with only 22 bullish hedge fund positions. Compared to these stocks Youdao, Inc. (NYSE:DAO) is even less popular than ENS. Our overall hedge fund sentiment score for DAO is 25.1. Stocks with higher number of hedge fund positions relative to other stocks as well as relative to their historical range receive a higher sentiment score. Hedge funds dodged a bullet by taking a bearish stance towards DAO. Our calculations showed that the top 20 most popular hedge fund stocks returned 41.3% in 2019 and outperformed the S&P 500 ETF (SPY) by 10 percentage points. These stocks gained 32.9% in 2020 through December 8th but managed to beat the market again by 16.2 percentage points. Unfortunately DAO wasn’t nearly as popular as these 20 stocks (hedge fund sentiment was very bearish); DAO investors were disappointed as the stock returned 8% since the end of the third quarter (through 12/8) and underperformed the market. If you are interested in investing in large cap stocks with huge upside potential, you should check out the top 20 most popular stocks among hedge funds as most of these stocks already outperformed the market so far in 2020.

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