7 Stocks the World's Greatest Hedge Fund Managers Love

Niccolo Machiavelli put it best:

A prudent man should always enter by the paths beaten by great men and imitate those who have been most excellent, so that, if his own skill does not come up to theirs, at least it will give off something of the odor of theirs.

Follow the smart people. Watch what they do. Learn from them. Copy their ideas. Simple stuff that can provide a good foundation for success.

Lucky for us, large investors like hedge funds are required to report their holdings every quarter. While slightly dated, this information gives us an inside peek into what some of the smartest minds in the investment world are up to.

Using data from the tracking firm AlphaClone, I set out to find the top seven stocks that have attracted the most capital from hedge funds. Using an index of the 196 largest funds, here's what I found:


Total Stock Owned Among
 Top 196 Hedge Funds

Apple (Nasdaq: AAPL  )

$7.9 billion

JPMorgan Chase (NYSE: JPM  )

$4.8 billion

Bank of America (NYSE: BAC  )

$4.7 billion

Citigroup (NYSE: C  )

$3.9 billion

ExxonMobil (NYSE: XOM  )

$3.4 billion

Pfizer (NYSE: PFE  )

$3 billion

Microsoft (Nasdaq: MSFT  )

$2.9 billion

Source: AlphaClone.

Let's say a few words about these companies.

Apple's earnings growth -- 50% per year over the past five years -- is well-known and well-hyped. How that growth fits into the stock's valuation isn't as glorified. Shares trade at about 15 times forward earnings, which itself looks pretty attractive. But the bigger picture is even rosier. Apple's balance sheet is stuffed full of cash, and the company is completely debt-free. So although its market cap is $244 billion, its enterprise value is much less -- about $215 billion. Back out the cash, and Apple trades at a mere 12 times forward earnings. It is, in many ways, one of the fastest-growing large-cap companies on Earth, trading as if it were merely average, if not slightly below average.

Big banks
Bank of America, JPMorgan, and Citigroup are heavily owned by top hedge funds, but it's really one fund -- Paulson & Co. -- that has gone in headfirst. Of the amounts shown in the table above, Paulson & Co. alone makes up $2.4 billion of Bank of America and $1.9 billion of Citigroup. (Paulson & Co. is run by John Paulson, who made a bloody fortune shorting the housing market.)

One recent development that makes big banks more interesting is the updated Basel capital requirements. The new internationally agreed-upon rules require banks to hold higher minimum capital. Bank of America, JPMorgan, and Citigroup already hold more than the updated minimums, so the new rules don't mean much for them. Uncertainty over capital rules, however, is now removed, upping the odds that dividends will resume at normal levels in the near future. Owning bank stocks still makes me nauseated because it's so easy for the companies to distort reality, but hedge funds apparently feel differently. More power to 'em.

Something ain't right at ExxonMobil: The stock trades lower today than it did during the deepest depths of the financial crisis -- a time when crude was less than half today's price. The company trades at nine times forward earnings, spits off a 3% dividend, and in 2009 bought back stock worth more than twice what it paid out in dividends. Put another way, if ExxonMobil stopped repurchasing shares, it could have been paying what amounts today to a 9% dividend.

Why are shares suddenly so cheap? The most logical explanation is that BP's oil disaster turned investors away from the entire industry. At a recent conference I attended, an oil analyst noted that the insurance industry placed the odds of a large rig blowing up at zero percent before the BP spill. So this industry's risks are now being reevaluated. Still, current valuations seem patently ridiculous and provide plenty of room for error.

The tides have shifted: Bonds are now the preferred vehicle of capital growth; stocks are where you find income. Sheer madness, I'm aware. But that's today's world. Better to face reality than laugh at it.

Pfizer's 4.2% dividend is one of the market's most attractive. Not necessarily because of its amount -- higher yields can be found. But the amount Pfizer pays out as dividends equals only about one-third of its 2009 free cash flow. So not only is this dividend high, but it's fairly safe based on historical cash flow. That's an attractive combination. 

Back out the cash, and Microsoft trades at roughly eight times forward earnings. "That's insanely cheap for a company of this caliber and market position" says hedge fund manager Whitney Tilson.

I agree. Take a stock with a thick moat, add in a bulletproof balance sheet, and mix in a valuation that's way below market averages and you're not likely to end up disappointed. Microsoft is a great example of what investors should be looking for these days: an established large cap with tons of cash, a business model not dependent on discretionary consumer spending, and broad geographic exposure. Double dip or otherwise, those kinds of companies will keep chugging along.

Thoughts? Comments? Fire away in the comments section below.

Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics.

Fool contributor Morgan Housel owns shares of Microsoft and ExxonMobil. Microsoft and Pfizer are Motley Fool Inside Value recommendations. Apple is a Motley Fool Stock Advisor selection. Motley Fool Options has recommended a diagonal call position on Microsoft. The Fool owns shares of Microsoft. Try any of our Foolish newsletter services free for 30 days. True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community. The Fool has a disclosure policy.

Read/Post Comments (11) | Recommend This Article (19)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 14, 2010, at 2:09 PM, rodgerreno wrote:

    when the greatest fund managers in the world own your stock --it is time to take profits or sell all together--a hedge fund owning a large per cent of a stock that you own has it's own hazards--think stock manipulation.--the stocks in this article are probably too large for hedge funds to make much impact

  • Report this Comment On September 14, 2010, at 5:59 PM, plange01 wrote:

    lets not forget goog and gs!without the trash funds holding these two up they would be penny stocks!

  • Report this Comment On September 14, 2010, at 10:11 PM, RegLeCrisp wrote:

    A great company isn't necessarily a great stock. Microsoft themselves confirmed this by wisely borrowing at historically low rates to buy back stock, all but confirming what most investors should already know: they are no longer a growth company. When (if?) rates start to rise and stabilize they will (or at least should) have to start paying a dividend to attract interest. Not to mention judging a stock by how many hedge funds own it is a dicey proposition at best, their motivations being so different from the average investor. Or maybe I have it all wrong and MSFT is just a screaming value of a stock...not an easy argument to make for such a liquid and high profile stock. At any rate, if I wake up one morning and MSFT is yielding 2.5%, I am in.

  • Report this Comment On September 14, 2010, at 11:45 PM, RegLeCrisp wrote:

    Let's make that 3.5%

  • Report this Comment On September 15, 2010, at 11:35 AM, TheDumbMoney wrote:

    RegLeCrisp, first of all, you changed that to 3.5 because you ex post looked up MSFT and realized the dividend is already 1.8 percent, and they actually initiated their dividend something like seven years ago. Also, large stocks can absolutely have periods of under-valuation, just as small, "undiscovered" stocks can at times be way over-valued: to see that, look for example at AIRT, which briefly spiked super high earlier this year, likely on some speculative trading, which has much more impact on small stocks; or look at the CCF nonsense in 2007. As to "liquid and high profile" large caps, KO is one of Buffett's best all-time investments, and maybe his best open-market stock investment of all time, it made BRK a ton of money simply because of when he bought in the late 1980s. I would argue that when people perceive there to be an existential threat to the fundamental business model of a famous large cap, you can potentially see some of the greatest values of all, if in fact that threat is more perception than reality. Thus, you saw MO trade at a ridiculously low multiple in the late nineties, before the Supreme Court ruled in a case involving MO that punitive damages had to be informally capped at around 10x actual damages, and that a single case could not seek damages based on the injuries of others, or based on societal wrong. Huge gains were had by those like me who immediately recognized the meaning of the Supreme Court's ruling, and who relatedly saw the settlement with the states as nothing more than a risk-reducer. At the same time, on the other hand, the perceived existential threat to EK's business model (from the transition to digital photography) proved to be totally correct. Today similar fears have arisen about companies like MSFT and INTC: the issue is whether the rise of AAPL and relatedly of mobile computing, in which they are relatively minor players, an existential threat? And will the desktop go dodo? And with MSFT, is Chrome, etc., and Google Docs an existential threat? I.e., will MSFT and/or INTC go the way of EK's stock price? Many people believe this is so. These are massive perceived threats, and worrying about them is not silly. Thus, many people are not investing in such companies, and poo-poo any growth that is estimated for them. If you believe, as I do, that: 1) while it is unfortunate that MSFT has not played well in smart phones, this is not going to eat their business, because it's a new market; 2) iPads are not going to replace laptops (and certainly not desktops) but are instead at least in part a new market (ever seen a realtor or landscape architect carrying a laptop whereever they go? -- I thought not); 3) Bing is as much an existential threat to Google as Chrome/Google Docs, etc., are to MSFT, if not more so because of the dynamics of their respective moats; and a few more things I intuit rightly or wrongly, then MSFT might just be very undervalued right now, because it is stuck in a pessimism bubble, which I like to call a pessimistic black hole, the irrational opposite of a bubble. Best to think of the market as a manic-depressive; efficiency arrives for most stocks only at fleeting moments, and the rest of the time they spent in euphoric clouds or in depressive cesspools. This is true of stocks no matter their market cap, its just that with small caps you usually have more potential for multi-bag growth (as well as for bankruptcy).

  • Report this Comment On September 16, 2010, at 11:33 AM, RegLeCrisp wrote:


    You are 100% correct on your first point! But check out the chart on the last 10 years, I would rather wait for Godot than for the market to be 'right' on this stock. Like I said, there is no doubt MSFT is a great company and probably undervalued, but it's like that friend who tells you if you don't like Frank Zappa you just haven't heard the right album yet: MSFT owners have got to be a little tired of trying to find that album. For those who do buy now, might I suggest writing some calls @28.50 or so to make the waiting a little easier? By the way, I know a lot of realtors in Boston and they actually do carry their laptops everywhere, I think I missed your point on that, though.

  • Report this Comment On September 16, 2010, at 12:13 PM, RegLeCrisp wrote:

    Also wanted to add that I do beleive that large caps can be great long term values (JNJ), and while KO is liquid and high profile it does not play on the same field as MSFT. They may seem to share some of the same competitive advantages, but MSFT always has a massive orc army right outside its gates (no pun intended). Coke lives in a truly unassailable castle and simply can't be taken on, whereas competitors have made concrete inroads into some of MSFT's bread and butter businesses and they seem to be constantly in a defensive position. My real point is that the technology space is incredibly scary and has taken on the look of the retail industry where fashion is now king and MSFT is the Salvation Army store.

  • Report this Comment On September 16, 2010, at 12:53 PM, TheDumbMoney wrote:

    Good points RegLeCrisp! I agree MSFT is not on KOs level, which is why I made the points about whether there is an existential threat to MSFT. I see the threats, I see them cutting into MSFT's future growth opportunities, but I don't see them either eliminating those growth opportunities or demolishing MSFT's present base. MSFT too has some pretty big moats built on collective use issues and switching costs. Also, while I am a big fan of KO, it is important to look past the CocaCola brand, which is where KO's ginormous moat is, and where growth is stagnant, at least in the U.S. PEP and other companies have actually done an impressive job of competing with and in some cases beating KO in non-beverage products, and bottled water, etc., etc., so I would be careful not to overestimate KO. But I think it has signficant international growth opportunities in front of it. I agree the technology space has taken on some aspects of fashion, which I find funny, though this actually makes me more worried about a company like APPL, which is at the apex of its fashionability. Recall that in the early eighties it was here before. One Steve Jobs liver hemorrage, and it could go down again. But I am also acutely aware of the hatred many people feel (whether justified or not) for MSFT, and of the orcs. I am also acutely aware that I may not know what I'm talking about at all.

  • Report this Comment On September 16, 2010, at 1:03 PM, TheDumbMoney wrote:

    Also, re: your fashion/retail analogy, I would say: MSFT is WMT (cheap, ubiquitous, mildly hated, utilitarian); GOOG is TGT (almost as cheap, trying to become as ubiquitous, more similar to MSFT than it wants to admit, and trying to become MSFT, but without admitting it, and while fooling people into thinking it is 'different'); and APPL is some high end/trendy/yet affortable retail boutique mall near one (one just found it, and one is so exited about it, because it is totally unique and special..., but actually the developer is a giant national company that is putting equally "totally unique and special" high end/trendy/yet affortable retail boutique malls in every medium to large city in America.

  • Report this Comment On September 17, 2010, at 9:57 AM, RegLeCrisp wrote:

    Very good...we should both be on Wall St. making 7 figure bonuses. Speaking of which, I love watching CNBC when they have 2 high profile commentators making opposite predictions: one will inevitably be mostly wrong, one will be mostly right. I'm no math whiz but the probability implications are an astonishing indictment on the industry. The best solution for the common investor: flip a coin and save the 175 basis point management fee. An immediate 1.75% return! OK, maybe that's a little pessimistic, I've only had one coffee today.

  • Report this Comment On September 17, 2010, at 10:12 AM, RegLeCrisp wrote:

    As an aside, I play KO via FMX. They distribute Coke in Latin America, investors balked when they exchanged their beer business for a chunk of Heineken, but I've always thought their biggest strength is their dominant chain of convenience stores. What was this article about again?

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