Were Hedge Funds Right About Embracing Discover Financial Services (DFS)?

Reymerlyn Martin
·6 min read

While the market driven by short-term sentiment influenced by the accomodative interest rate environment in the US, virus news and stimulus talks, many smart money investors are starting to get cautious towards the current bull run since March and hedging or reducing many of their long positions. Some fund managers are betting on Dow hitting 30,000 to generate strong returns. However, as we know, big investors usually buy stocks with strong fundamentals that can deliver gains both in bull and bear markets, which is why we believe we can profit from imitating them. In this article, we are going to take a look at the smart money sentiment surrounding Discover Financial Services (NYSE:DFS).

Discover Financial Services (NYSE:DFS) was in 44 hedge funds' portfolios at the end of the second quarter of 2020. The all time high for this statistics is 52. DFS has seen an increase in activity from the world's largest hedge funds lately. There were 40 hedge funds in our database with DFS holdings at the end of March. Our calculations also showed that DFS isn't among the 30 most popular stocks among hedge funds (click for Q2 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.

Why do we pay any attention at all to hedge fund sentiment? Our research has shown that a select group of hedge fund holdings outperformed the S&P 500 ETFs by 56 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'll significantly underperform the market. We have been tracking and sharing the list of these stocks since February 2017 and they lost 34% through August 17th. That's why we believe hedge fund sentiment is an extremely useful indicator that investors should pay attention to.

Eashwar Krishnan - Tybourne Capital
Eashwar Krishnan - Tybourne Capital

Eashwar Krishnan of Tybourne Capital Management

At Insider Monkey we scour multiple sources to uncover the next great investment idea. Hedge fund sentiment towards Tesla reached its all time high at the end of 2019 and Tesla shares more than quadrupled this year. We are trying to identify other EV revolution winners, so we are checking out this under-the-radar lithium stock. We go through lists like the 10 most profitable companies in the world 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 to get excerpts of these letters in your inbox. Keeping this in mind let's take a peek at the key hedge fund action surrounding Discover Financial Services (NYSE:DFS).

What does smart money think about Discover Financial Services (NYSE:DFS)?

At the end of the second quarter, a total of 44 of the hedge funds tracked by Insider Monkey were long this stock, a change of 10% from the first quarter of 2020. The graph below displays the number of hedge funds with bullish position in DFS over the last 20 quarters. With hedge funds' positions undergoing their usual ebb and flow, there exists a few noteworthy hedge fund managers who were upping their stakes significantly (or already accumulated large positions).

According to publicly available hedge fund and institutional investor holdings data compiled by Insider Monkey, Eashwar Krishnan's Tybourne Capital Management has the biggest position in Discover Financial Services (NYSE:DFS), worth close to $198.7 million, corresponding to 6% of its total 13F portfolio. On Tybourne Capital Management's heels is Lone Pine Capital, founded by Stephen Mandel, which holds a $102 million position; 0.5% of its 13F portfolio is allocated to the company. Remaining members of the smart money with similar optimism consist of Ike Kier and Ilya Zaides's KG Funds Management, Ken Griffin's Citadel Investment Group and James Parsons's Junto Capital Management. In terms of the portfolio weights assigned to each position KG Funds Management allocated the biggest weight to Discover Financial Services (NYSE:DFS), around 8.75% of its 13F portfolio. East Side Capital (RR Partners) is also relatively very bullish on the stock, earmarking 6.43 percent of its 13F equity portfolio to DFS.

As industrywide interest jumped, key hedge funds have jumped into Discover Financial Services (NYSE:DFS) headfirst. Tybourne Capital Management, managed by Eashwar Krishnan, initiated the most outsized position in Discover Financial Services (NYSE:DFS). Tybourne Capital Management had $198.7 million invested in the company at the end of the quarter. Lone Pine Capital also initiated a $102 million position during the quarter. The other funds with new positions in the stock are Ike Kier and Ilya Zaides's KG Funds Management, James Parsons's Junto Capital Management, and Kevin D. Eng's Columbus Hill Capital Management.

Let's also examine hedge fund activity in other stocks similar to Discover Financial Services (NYSE:DFS). We will take a look at Vulcan Materials Company (NYSE:VMC), Telefonica Brasil SA (NYSE:VIV), Quest Diagnostics Incorporated (NYSE:DGX), Cardinal Health, Inc. (NYSE:CAH), Tractor Supply Company (NASDAQ:TSCO), CBRE Group, Inc. (NYSE:CBRE), and BioNTech SE (NASDAQ:BNTX). This group of stocks' market values resemble DFS's market value.

[table] Ticker, No of HFs with positions, Total Value of HF Positions (x1000), Change in HF Position VMC,51,879902,2 VIV,12,99788,4 DGX,46,804000,8 CAH,49,956785,5 TSCO,38,828499,1 CBRE,29,1442786,-4 BNTX,15,367554,9 Average,34.3,768473,3.6 [/table]

View table here if you experience formatting issues.

As you can see these stocks had an average of 34.3 hedge funds with bullish positions and the average amount invested in these stocks was $768 million. That figure was $741 million in DFS's case. Vulcan Materials Company (NYSE:VMC) is the most popular stock in this table. On the other hand Telefonica Brasil SA (NYSE:VIV) is the least popular one with only 12 bullish hedge fund positions. Discover Financial Services (NYSE:DFS) is not the most popular stock in this group but hedge fund interest is still above average. Our overall hedge fund sentiment score for DFS is 75.4. 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 10 most popular stocks among hedge funds returned 41.4% in 2019 and outperformed the S&P 500 ETF (SPY) by 10.1 percentage points. These stocks gained 30% in 2020 through October 23rd and still beat the market by 21 percentage points. Hedge funds were also right about betting on DFS as the stock returned 36.9% since the end of Q2 (through 10/23) and outperformed the market. Hedge funds were rewarded for their relative bullishness.

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

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