After a decade of neglect, value stocks have landed on investors’ radar again in dramatic fashion following the November 9 announcement that Pfizer Inc. (NYSE:PFE) and BioNTech’s Covid-19 vaccine candidate is more than 90% successful at preventing infection by the coronavirus.
According to JPMorgan, that announcement lead to the biggest one-day gains for value stocks (over 6%) alongside the biggest one-day drop in momentum stocks (a slide of nearly 14%) in history. While growth stocks are still the big winners of the pandemic thus far, gaining over 25%, the pandemic finish line materializing a little more resolutely into place has seemingly shaken the market out of the dream-like pandemic grace period it had fallen into, where assumptions about post-pandemic growth could rule the day in lieu of more tangible data.
In a post-pandemic world where bond yields and inflation are likely to accelerate, even greater pressure will be put on growth stocks to meet the lofty expectations investors have placed on them, including living up to a P/E ratio of 38x according to Citigroup, which is approaching perilously close to the dot-com bubble’s peak hubris of a 47x P/E. On the other hand, there is plenty of potential room to run for value stocks, which are still down by over 5% in 2020 and trade at a P/E of just 17x.
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To uncover a list of promising value stocks we turned to Marc Majzner’s Clearline Capital, a catalyst-driven long/short equity hedge fund based in New York which has a focus on mid-cap stocks. The fund applies a value investing approach to its broader strategy, with a focus on cheap, catalyst-driven stocks that display compelling risk/reward profiles of greater than 50% upside and less than 15% downside. Mr. Majzner, who serves as Clearline’s Portfolio Manager, launched the fund in 2012 with $70 million in seed money from Talpion Fund Management and its Founder Henry Swieca after Mr. Majzner’s 17-month stint as Senior Portfolio Manager at Talpion.
Clearline Capital Partners LP is coming off a tremendous 2019 in which the fund returned 60.84%, lifting its compound annual return above 11% through April 2020. That followed a rough stretch during which the fund had negative returns during three of the prior four years and saw its assets under management plummet. Clearline Capital had $381 million in assets under management at the end of June 2020, down from $1.44 billion in September 2016.
Clearline Capital was relatively busy during the September quarter, adding 34 stocks to its portfolio and building larger stakes in 28 of its existing holdings. Of its seven largest positions on September 30, the fund was bullish on all of them during Q3. We’ll take a closer look at those holdings below, as well as three other stocks the fund has been buying up recently.
There’s a very good reason why we pay close attention to hedge fund sentiment before making 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, though 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 S&P 500 ETFs by more than 66 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 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.
Let’s check out ten of the catalyst-driven value stocks that Clearline Capital expects big things from in the months to come.
Our list kicks off with ACI Worldwide Inc (NASDAQ:ACIW), a payments processor which activist investor Jeffrey Smith of Starboard Value has also taken a keen interest in recently, building a 9% ownership stake in the company and calling it an “attractive” takeover target. Clearline Capital opened a new position in ACIW during Q3 consisting of 203,241 shares.
Smith presented ACI Worldwide at the Capitalize for Kids investors conference in October, noting that the company has massively underperformed its peers over the past five years and trades at a sharp valuation discount to many of them despite a strong collection of assets. In lieu of a full sale, ACI could alternatively look to break itself up, separating its higher growth bill paying unit from its high-margin software business.
Clearline Capital acquired 285,851 shares of DXC Technology Co (NYSE:DXC) during Q3, making a huge addition to the small position in the stock that it had maintained since selling off the vast majority of its DXC holding in Q2. The IT services company was Clearline’s top stock pick between Q3 2019 and Q1 2020.
In its final investor letter of 2019, David Einhorn’s Greenlight Capital detailed some of the initiatives DXC has been undertaking and expressed optimism that the company was on the right track with its new strategic focus:
“After a difficult post-merger period that resulted in substantial lost business, DXC brought on a new CEO with previous experience managing a successful turnaround of a similar operation. Subsequently, the company has announced a new strategy to refocus on DXC’s core business and leverage it with clients. DXC also lowered earnings expectations through 2022. The company has begun the process of divesting ancillary businesses totaling about 25% of revenue, with the proceeds targeted to pay down debt and buy back over one-third of shares outstanding over the next 10 quarters. We believe many of the challenges at the company are self-inflicted and can be fixed. Our field research reveals early signs that improvement is underway, and at our average purchase price of $36.54 (7x the reduced current year consensus earnings) we think little of that is priced in. DXC ended the quarter at $37.59.”
Marc Majzner’s hedge fund took a position in American Eagle Outfitters Inc. (NYSE:AEO) during Q2 and added another 248,954 shares to it in Q3, building a $5.85 million position as of the end of September. Clearline was one of several funds to take stakes in AEO during Q2, as there was a 38% surge in ownership of the stock among the exclusive group of hedge funds that Insider Monkey tracks.
Shares of the retailer have gained 25% in the fourth quarter, but still trade at a discount rack price of about 9x earnings. While sales were still down year-over-year at its flagship locations in Q3, its digital sales posted 29% gains from a year ago, while its Aerie lingerie division delivered a 34% sales boost and could triple sales over the next five years according to Jefferies. AEO suspended its dividend in June and undertook several other initiatives in Q2 in light of the pandemic, which helped the company achieve strong margins in Q3.
Clearline Capital took a stake in The Brink’s Company (NYSE:BCO) during the second quarter of this year, shortly after Brink’s announced that it would acquire storage services company G4Si, as well as the cash operations of G4S in 17 markets. Clearline made another big investment in Brink’s during Q3, buying another 267,429 BCO shares.
The security services company’s shares are still well off their pre-pandemic levels but have gained 68% in Q4. Brink’s has handily beaten estimates in each of the past two quarters and expects revenue to rebound close to 2019 levels next year while delivering what would amount to record adjusted EBITDA of between $615 million and $805 million.
Hedge fund ownership of Macquarie Infrastructure Corporation (NYSE:MIC) cratered between 2015 and 2017, preceding a massive decline in the stock in early 2018 when the fuel storage company cut its dividend payments in order to focus on tax-incentivized growth projects. It appears some of those investments have been paying off, as hedge funds have been buying back into the stock since the start of 2019.
Clearline Capital was one of those funds, opening a stake in MIC during the fourth quarter of last year, during which the company announced it was pursuing strategic alternatives. In the third quarter, Clealine bought another 143,311 MIC shares, giving it 588,249 overall and a $15.82 million position in the company as of September 30. Earlier this month, Macquarie announced that it will sell its IMTT unit for $2.7 billion and pay out a special dividend of $10.75 per share at some point following the sale’s close.
Click to continue reading and see the5 Best Catalyst-Driven Value Stocks to Buy Now. Disclosure: None. 10 Best Catalyst-Driven Value Stocks to Buy Now is originally published at Insider Monkey.
