This Metric Says Investors Should Bet On Only 1 Of These 2 Collapsing Stocks

Shares of social media company Twitter Inc (NYSE:TWTR) are down by 3.88% and shares of equipment manufacturer Caterpillar Inc. (NYSE:CAT) are down by 5.97% in afternoon trading today. Let’s take a closer look at why the two stocks are falling and see whether hedge fund sentiment suggests that the declines were predicted, or that the market is overreacting.

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We pay attention to hedge funds’ moves because our research has shown that hedge funds are extremely talented at picking stocks on the long side of their portfolios. It is true that hedge fund investors have been underperforming the market in recent years. However, this was mainly because hedge funds’ short stock picks lost a ton of money during the bull market that started in March 2009. Hedge fund investors also paid an arm and a leg for the services that they received. We have been tracking the performance of hedge funds’ 15 most popular small-cap stock picks in real time since the end of August 2012. These stocks have returned 118% since then and outperformed the S&P 500 Index by around 60 percentage points (see the details here). That’s why we believe it is important to pay attention to hedge fund sentiment; we also don’t like paying huge fees.

Caterpillar Inc. (NYSE:CAT) announced layoffs of up to 10,000 employees as part of its restructuring program, citing “challenging marketplace conditions in key regions and industry sectors – namely in mining and energy“. Although shares of companies that announce layoffs typically rally on the news, Caterpillar shares sold off because the layoffs show future demand isn’t as rosy as expected. Shares of the capital equipment manufacturer are down by more than 25% year-to-date now as the Chinese economy slows and energy and mining companies cut capital expenditures. With crude trading below $50 per barrel and many commodities down by at least 50% from their peak, the demand picture seemingly won’t improve any time soon. After the drop, shares of Caterpillar trade at a forward P/E of 15 and trailing twelve month P/E of 12.

In contrast to the market, hedge funds are bullish on Caterpillar Inc. (NYSE:CAT). According to our database of around 730 funds, the total number of hedge funds long Caterpillar increased to 30 at the end of June from 28 at the end of March. Meanwhile, the total value of hedge funds’ holdings declined to $1.36 billion (2.7% of the float) from $1.46 billion on March 31. Among the hedge funds that increased their positions in the second quarter were Matthew Hulsizer’s Peak6 Capital Management, which increased its holding by 97% to 245,772 shares, and Paul Tudor Jones’ Tudor Investment Corp, which upped its position by 17% to 68,594 shares. Michael Larson‘s Bill & Melinda Gates Foundation Trust kept its position the same at 11.26 million shares. 

Twitter Inc (NYSE:TWTR)‘s shares are down after market research firm eMarketer cut its global ad revenue estimate for the social medial company, while Citigroup analyst Mark May cut his price target to $30 from $37 and downgraded the stock to ‘Neutral/High Risk’ from ‘Neutral’. May doesn’t believe Twitter can meet consensus monetization forecasts in the quarter ahead. Twitter hasn’t found a permanent CEO yet, and the leadership uncertainty comes at a delicate time for Twitter, as the social media company struggles to monetize and grow its audience. Shares of Twitter are down by 25% year-to-date and trade at a forward P/E of 42.8.

The performance of the company and its stock seems to be aligned with hedge fund sentiment, as the funds tracked by Insider Monkey were very bearish on Twitter during the second quarter. The total number of hedge funds long Twitter Inc (NYSE:TWTR) declined to 47 by the end of the second quarter from 64 in the quarter prior. The total value of hedge funds’ holdings declined to $701 million (2.9% of the float) at the end of June from $1.75 billion at the end of March. David Shaw‘s D. E. Shaw increased its position of put options on Twitter by 115% to cover 2.2 million underlying shares.

Disclosure: None