Hedge Fund Darlings That Look Like ‘Sells’

by Nancy Zambell | May 31, 2012 12:00 pm

Yesterday, I discussed the top 50 stocks held by hedge funds[1], via a study by Goldman Sachs (NYSE:GS[2]), and noted the mere 13 that technically look promising.

Today, I want to talk about 14 of those 50 stocks that hedge funds can’t get enough of — yet each one is rated a “strong sell” by my technical parameters.

company ticker symbol price ($) technical rating consensus analyst
recommendation
(1 is the highest)
Microsoft MSFT 29.34 Strong Sell 2.0
Qualcomm QCOM 57.45 Strong Sell 1.9
Citigroup C 26 Strong Sell 2.3
JPMorgan Chase JPM 32.96 Strong Sell 2.0
BP BP 37.02 Strong Sell 1.6
Andarko Petroleum APC 62.24 Strong Sell 1.8
Cisco Systems CSCO 16.39 Strong Sell 2.3
Liberty Interactive LINTA 16.95 Strong Sell 1.6
Visteon VC 41.10 Strong Sell 2.4
Valeant Pharmaceuticals VRX 47.92 Strong Sell 3.0
CIT Group CIT 34.10 Strong Sell 2.1
Devon Energy DVN 59.75 Strong Sell 2.0
EMC EMC 24.03 Strong Sell 1.7
Illumina ILMN 44.33 Strong Sell 2.4

You might ask, “Why is the so-called smart money in these unpromising stocks?”

It’s a good question. And after reading yesterday’s article[3] and noting the analysts’ consensus recommendations on my “buy” and “strong buy” companies, I hope you’ll see a pattern and ask a second question.

For the majority of both yesterday’s buys and today’s sells, the consensus analyst rankings are pretty darn good — close to the top rating of 1.

So your next question should be, “Why are all the so-called smart minds on Wall Street giving good ratings to all of these companies?”

The answer isn’t what you’re led to believe by the Wall Street hype machine.

The big players — the analysts, the institutions, and their buddies, the hedge fund gurus — all sort of hang out in the same neighborhood and follow the same kinds of companies, primarily the large-caps. There are several reasons for this, and not all of them are bad.

First, let’s take the analysts and their employers, the brokerage firms and investment banks. It’s generally the larger businesses that need Wall Street’s money and expertise to underwrite their initial public offerings as well as their secondary equity and debt offerings. Consequently, the research departments of these investment houses will generally have an analyst or two following their clients’ shares, issuing nice buy reports and trying to get the public to invest in them.

There’s nothing wrong with that, except when the research departments and investment bankers get too close, jumping over the Chinese Wall, which is the way Wall Street does business.

As you can see by the narrow range of their ratings on just these few stocks, analysts don’t often go out on a limb to separate themselves from the pack mentality. The majority of their ratings are pretty positive, with few exceptions. After all, they wouldn’t want to make their big clients mad by issuing a sell rating, would they? Consequently, their recommendations are neither objective nor a clear picture of a company’s potential.

Next, the institutions. Who do you think these folks talk to all day? That’s right — analysts and investment bankers. Much of their research is purchased from brokerage houses. So they’re predisposed to buying shares in the largest companies — i.e., the ones the analysts like.

In their defense, these guys have a lot of money to throw around, so they do have to be careful that their purchases of shares don’t actually move the market for a stock. Hence, they tend to play mostly in the big-cap arena with their largest purchases.

Lastly, the hedge fund managers. Same deal as the institutions. The big difference is that hedge funds will often take very lopsided positions, betting big — either long or short — and that’s where they have their greatest successes as well as their largest losses. Just ask John Paulson.

You’ll remember his name from the mortgage meltdown. He was a big player who bet short against the Goldman Sachs clients who were buying the same securities. In 2007, he made $3.7 billion, according to Wikipedia. Last year, his Advantage Plus Fund was down more than 50%, and his Advantage Fund lost more than 35%, according to Insider Monkey.

When I started this series of articles on hedge funds[4], I asked if you wanted to play with the big boys.

I hope your answer by now is “no.”

Even in their good years, hedge funds take enormous risks that most individual investors should never contemplate.

There’s certainly a time and place to invest in large caps, and as I noted yesterday, some of those Top 50 names look pretty good, technically speaking, right now. But for most investors, a balanced, diversified portfolio is the optimal way to go.

Next week, I’ll give you some tips on how to structure your ideal portfolio. Just remember, you’re just as smart as the “big money,” and individual investors can do just as well or even better than the big boys — with a lot less risk.

Endnotes:
  1. I discussed the top 50 stocks held by hedge funds: http://investorplace.com/2012/05/top-50-hedge-fund-stocks-only-13-are-buys/
  2. GS: http://studio-5.financialcontent.com/investplace/quote?Symbol=GS
  3. reading yesterday’s article: http://investorplace.com/2012/05/top-50-hedge-fund-stocks-only-13-are-buys/
  4. When I started this series of articles on hedge funds: http://investorplace.com/2012/05/do-you-have-hedge-fund-envy-dont/

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