Should I Avoid Energy Recovery, Inc. (ERII)?

Although the masses and most of the financial media blame hedge funds for their exorbitant fee structure and disappointing performance, these investors have proved to have great stock picking abilities over the years (that’s why their assets under management continue to swell). We believe hedge fund sentiment should serve as a crucial tool of an individual investor’s stock selection process, as it may offer great insights of how the brightest minds of the finance industry feel about specific stocks. After all, these people have access to smartest analysts and expensive data/information sources that individual investors can’t match. So should one consider investing in Energy Recovery, Inc. (NASDAQ:ERII)? The smart money sentiment can provide an answer to this question.

Energy Recovery, Inc. (NASDAQ:ERII) shareholders have witnessed a decrease in activity from the world’s largest hedge funds in recent months. Energy Recovery, Inc. (NASDAQ:ERII) was in 11 hedge funds’ portfolios at the end of the third quarter of 2020. The all time high for this statistics is 16. Our calculations also showed that ERII 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.

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 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. 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.

David Harding of Winton Capital Management

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 we’re going to take a glance at the recent hedge fund action surrounding Energy Recovery, Inc. (NASDAQ:ERII).

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

Heading into the fourth quarter of 2020, a total of 11 of the hedge funds tracked by Insider Monkey were bullish on this stock, a change of -8% from one quarter earlier. By comparison, 10 hedge funds held shares or bullish call options in ERII a year ago. With hedge funds’ positions undergoing their usual ebb and flow, there exists an “upper tier” of key hedge fund managers who were increasing their stakes substantially (or already accumulated large positions).

More specifically, Trigran Investments was the largest shareholder of Energy Recovery, Inc. (NASDAQ:ERII), with a stake worth $46.4 million reported as of the end of September. Trailing Trigran Investments was 683 Capital Partners, which amassed a stake valued at $4.3 million. Arrowstreet Capital, Elkhorn Partners, and Citadel Investment Group were also very fond of the stock, becoming one of the largest hedge fund holders of the company. In terms of the portfolio weights assigned to each position Trigran Investments allocated the biggest weight to Energy Recovery, Inc. (NASDAQ:ERII), around 8.4% of its 13F portfolio. Elkhorn Partners is also relatively very bullish on the stock, designating 0.43 percent of its 13F equity portfolio to ERII.

Due to the fact that Energy Recovery, Inc. (NASDAQ:ERII) has faced falling interest from the aggregate hedge fund industry, it’s safe to say that there was a specific group of funds that elected to cut their entire stakes heading into Q4. It’s worth mentioning that Renaissance Technologies dropped the biggest position of all the hedgies tracked by Insider Monkey, comprising close to $0.3 million in stock, and Israel Englander’s Millennium Management was right behind this move, as the fund said goodbye to about $0.2 million worth. These transactions are intriguing to say the least, as aggregate hedge fund interest fell by 1 funds heading into Q4.

Let’s check out hedge fund activity in other stocks similar to Energy Recovery, Inc. (NASDAQ:ERII). These stocks are Watford Holdings Ltd. (NASDAQ:WTRE), American Software, Inc. (NASDAQ:AMSWA), Inventiva S.A. (NASDAQ:IVA), Ennis, Inc. (NYSE:EBF), Bank First Corporation (NASDAQ:BFC), Digi International Inc. (NASDAQ:DGII), and Boston Private Financial Hldg Inc (NASDAQ:BPFH). All of these stocks’ market caps resemble ERII’s market cap.

View table here if you experience formatting issues.

As you can see these stocks had an average of 10.3 hedge funds with bullish positions and the average amount invested in these stocks was $31 million. That figure was $54 million in ERII’s case. Boston Private Financial Hldg Inc (NASDAQ:BPFH) is the most popular stock in this table. On the other hand Bank First National Corporation (NASDAQ:BFC) is the least popular one with only 1 bullish hedge fund positions. Energy Recovery, Inc. (NASDAQ:ERII) is not the most popular stock in this group but hedge fund interest is still above average. Our overall hedge fund sentiment score for ERII is 48.4. 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. Our calculations showed that top 20 most popular stocks among hedge funds 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 and still beat the market by 16.2 percentage points. Hedge funds were also right about betting on ERII as the stock returned 42.8% since the end of Q3 (through 12/8) and outperformed the market. Hedge funds were rewarded for their relative bullishness.

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