Should You Avoid A. O. Smith Corporation (AOS)?

It seems that the masses and most of the financial media hate hedge funds and what they do, but why is this hatred of hedge funds so prominent? At the end of the day, these asset management firms do not gamble the hard-earned money of the people who are on the edge of poverty. Truth be told, most hedge fund managers and other smaller players within this industry are very smart and skilled investors. Of course, they may also make wrong bets in some instances, but no one knows what the future holds and how market participants will react to the bountiful news that floods in each day. The Standard and Poor’s 500 Total Return Index ETFs returned approximately 27.5% in 2019 (through the end of November). Conversely, hedge funds’ top 20 large-cap stock picks generated a return of 37.4% during the same 11-month period, with the majority of these stock picks outperforming the broader market benchmark. Coincidence? It might happen to be so, but it is unlikely. Our research covering the last 18 years indicates that hedge funds’ consensus stock picks generate superior risk-adjusted returns. That’s why we believe it isn’t a waste of time to check out hedge fund sentiment before you invest in a stock like A. O. Smith Corporation (NYSE:AOS).

A. O. Smith Corporation (NYSE:AOS) shareholders have witnessed a decrease in hedge fund interest lately. AOS was in 18 hedge funds’ portfolios at the end of September. There were 22 hedge funds in our database with AOS holdings at the end of the previous quarter. Our calculations also showed that AOS isn’t among the 30 most popular stocks among hedge funds (click for Q3 rankings and see the video below for Q2 rankings).

Video: Click the image to 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 Russell 2000 ETFs by 40 percentage points since May 2014 (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.

John Overdeck of Two Sigma Advisors

Unlike the largest US hedge funds that are convinced Dow will soar past 40,000 or the world’s most bearish hedge fund that’s more convinced than ever that a crash is coming, our long-short investment strategy doesn’t rely on bull or bear markets to deliver double digit returns. We only rely on the best performing hedge funds‘ buy/sell signals. We’re going to take a look at the recent hedge fund action encompassing A. O. Smith Corporation (NYSE:AOS).

What have hedge funds been doing with A. O. Smith Corporation (NYSE:AOS)?

Heading into the fourth quarter of 2019, a total of 18 of the hedge funds tracked by Insider Monkey were bullish on this stock, a change of -18% from one quarter earlier. Below, you can check out the change in hedge fund sentiment towards AOS over the last 17 quarters. So, let’s check out which hedge funds were among the top holders of the stock and which hedge funds were making big moves.

Among these funds, Impax Asset Management held the most valuable stake in A. O. Smith Corporation (NYSE:AOS), which was worth $181.8 million at the end of the third quarter. On the second spot was Two Sigma Advisors which amassed $41.5 million worth of shares. Citadel Investment Group, Balyasny Asset Management, and Adage Capital Management 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 Water Asset Management allocated the biggest weight to A. O. Smith Corporation (NYSE:AOS), around 4.29% of its 13F portfolio. Impax Asset Management is also relatively very bullish on the stock, designating 2.37 percent of its 13F equity portfolio to AOS.

Seeing as A. O. Smith Corporation (NYSE:AOS) has witnessed bearish sentiment from the aggregate hedge fund industry, logic holds that there lies a certain “tier” of fund managers that elected to cut their entire stakes by the end of the third quarter. At the top of the heap, Andreas Halvorsen’s Viking Global dumped the biggest stake of all the hedgies monitored by Insider Monkey, comprising an estimated $115.6 million in stock. Steve Cohen’s fund, Point72 Asset Management, also dumped its stock, about $48.7 million worth. These bearish behaviors are intriguing to say the least, as aggregate hedge fund interest was cut by 4 funds by the end of the third quarter.

Let’s go over hedge fund activity in other stocks – not necessarily in the same industry as A. O. Smith Corporation (NYSE:AOS) but similarly valued. We will take a look at The Toro Company (NYSE:TTC), American Homes 4 Rent (NYSE:AMH), Apartment Investment and Management Company (NYSE:AIV), and Post Holdings Inc (NYSE:POST). All of these stocks’ market caps are similar to AOS’s market cap.

View table here if you experience formatting issues.

As you can see these stocks had an average of 23.5 hedge funds with bullish positions and the average amount invested in these stocks was $812 million. That figure was $330 million in AOS’s case. Post Holdings Inc (NYSE:POST) is the most popular stock in this table. On the other hand The Toro Company (NYSE:TTC) is the least popular one with only 19 bullish hedge fund positions. Compared to these stocks A. O. Smith Corporation (NYSE:AOS) is even less popular than TTC. Hedge funds dodged a bullet by taking a bearish stance towards AOS. Our calculations showed that the top 20 most popular hedge fund stocks returned 37.4% in 2019 through the end of November and outperformed the S&P 500 ETF (SPY) by 9.9 percentage points. Unfortunately AOS wasn’t nearly as popular as these 20 stocks (hedge fund sentiment was very bearish); AOS investors were disappointed as the stock returned 1.9% during the fourth quarter (through the end of November) 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 70 percent of these stocks already outperformed the market so far in Q4.

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