5 Stocks Hedge Funds Love -- and So Should You

BALTIMORE ( Stockpickr) -- There's a love story taking shape on Wall Street right now -- it's a hedge-fund-manager-meets-stock story. And the stocks hedge funds love in 2013 are worth noting this month.

Hedge funds spent much of the end of last year playing catch-up from a performance standpoint, trying to squeeze extra performance out of the market following what was a very strong year for stocks. To do that, they've been grabbing at more momentum names for the last quarter. But with a new calendar year a month in, hedge fund managers have been able to reset their performance clocks again and position themselves with names that still have some time to develop. Those are the ones that investors should be paying attention to.

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Hedge funds' favorite stocks are telling right now, especially because they're subject to less lag.

And since we're looking at fund holdings in the aggregate, they're less impacted by the fact that some funds haven't filed yet. Consider it a sampling of the $133 billion managed by hedge funds -- a sneak peak.

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Institutional investors with more than $100 million in assets are required to file a 13F, a form that breaks down their stock positions for public consumption. From hedge funds to mutual funds to insurance companies, any professional investors who manage more than that $100 million watermark are required to file a 13F. And by comparing one quarter's filing to another, we can see how any single fund manager is moving their portfolio around.

Without further ado, here's a look at five stocks hedge funds love.

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General Motors

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Detroit auto giant General Motors ( GM) has been enjoying some stellar performance in the last six months, rallying more than 42% since the end of the summer alone. That performance caught hedge funds' attention in the fourth quarter of 2012, with funds doubling their total holdings by picking up an extra 4.42 million shares. Ironically, hedge funds were big net sellers of GM in the prior quarter -- but they've since changed their tune on the carmaker.

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GM is a dramatically different company than it was just a few years ago. Following its tumultuous bankruptcy, the firm emerged cutting a new, more svelte corporate profile. A much lower breakeven point for the firm is a very big deal for investors, particularly after the auto industry built up a reputation for carrying insurmountable costs on their income statement. A government exit from the stock should ease some shareholder concerns over Uncle Sam's stake in the firm -- and help the firm lose its "Government Motors" moniker.

The real kicker is that GM has been building better cars. By slashing at the huge brand portfolio that the firm had built up over decades, it was able to get rid of redundant nameplates that offered little in the way of uniqueness and only confused consumers. Emerging markets like China and India still offer some big growth potential in the years ahead, as a burgeoning middle class starts becoming more mobile. And now, with stellar balance sheet health post-bankruptcy, the firm actually has the financial wherewithal to pull it off.


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When big pharma companies don't want to do the heavy lifting to develop a new drug, they farm the research out to Covance ( CVD). The firm provides a range of drug development and laboratory testing services to clients in the pharma, biotech and agrochem industries, digging out a highly profitable niche in the process.

Hedge funds love this stock right now. In the last quarter alone, funds picked up 2.34 million shares of the firm, building their current stake in the firm to $170 million.

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Covance offers some big advantages for its clients. Going with a contracted research firm can save time, money, and logistical costs from being borne by pharma firms themselves, instead spreading the huge cost of research facilities across CVD's more active client base during downtime. As big pharma firms increase their marketing and acquisition search efforts (at the expense of R&D), Covance's services help balance incentives a bit better.

The firm's long-term deals with big drugmakers such as Eli Lilly ( LLY) and Sanofi ( SAN) give it a big moat vs. other third-party research firms because they keep revenues at home. Scale doesn't hurt either; with bigger and better lab facilities than their next closest competitor, CVD is able to take on contracts that smaller research firms can't.

A spotless balance sheet with a big net cash position is a good signal for management's stewardship abilities in 2013. Momentum has been on fire for CVD in 2013. Investors looking for a relative strength play should follow hedge funds into this name.


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ADT ( ADT) spun off from Tyco International ( TYC) last fall, and it's been another stellar relative strength name ever since; shares are up more than 31% from their first trading session. Hedge funds love the stock too. They added 3.89 million shares in the last quarter, boosting their collective stake in the firm to $188 million.

ADT provides security, fire, and carbon monoxide monitoring services for more than 6.4 million residential and business customers in North America. That's a lucrative business for a few reasons. For starters, customers sign lucrative, relatively long-term contracts to add ADT's services, a practice that keeps multi-year retention rates extremely high. And because customers go to the trouble (and expense) of installing ADT hardware on their premises, switching costs are even higher.

There have been significant consolidations in the security business, but ADT remains the brand leader. Brand matters considerably for consumers looking for security services, a fact that gives ADT a big economic moat over competitors. ADT's newer Pulse platform adds more functionality to customers' security systems, adding value for owners and giving ADT a big source of coveted add-on service revenues. With high levels of profitability and a new standalone corporate positioning, expect ADT to continue to fare well in 2013.


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The recent housing market rebound has had a halo effect on any stock with a tie-in to housing or building, so it should come as no surprise that home improvement retailer Lowe's ( LOW) has been attracting more investors' eyes lately. Hedge funds haven't been immune to the draw; last quarter, hedge fund managers picked up 2.87 million shares of Lowe's, boosting their total ownership of the stock by 36%.

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A couple of factors make Lowe's stand out from the crowd. For starters, the firm has enjoyed slow but steady top line growth over the last few years, the result of consumers' willingness to spend on home improvement projects in place of spending on new homes. During the recession, the firm invested in better merchandising and increasing the presence of its store brands, two factors that have helped the company hang onto impressive margins for the retail industry. While Home Depot ( HD) has gotten more visibility from its conspicuous post-recession turnaround, Lowe's probably deserves more credit for staying consistently attractive.

Financially, Lowe's sports a balance sheet that could be a lot worse. While the firm has a net debt position, that's par for the course for a big-name retailer. More important, its financial obligations are easily covered by cash generation, and LOW's financial health doesn't look in question right here. As home improvement stocks continue to get bid up, Lowe's investors will keep getting rewarded for their patience.

Yum! Brands

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Last up on our list of hedge funds' favorite stocks is Yum! Brands ( YUM). Yum! owns an array of popular fast food restaurant concepts, including KFC, Taco Bell and Pizza Hut. The firm has more than 37,000 stores in 120 countries, making it the largest restaurant network in the world.

Yum! was one of the first U.S. fast food franchisors to open stores in China, and it's been one of the biggest beneficiaries in the consumption growth among the new Chinese middle class. Importantly, the firm was quick to embrace conforming to local tastes with new brands, rather than simply opening Taco Bell locations in Beijing. Despite being in the region for a while now, there's still a lot of growth to squeeze out of the region for Yum! in the next few years. Here at home, the franchise restaurant model is still lucrative for owners like Yum! Brands because it generates consistent recurring revenues, and gives the firm the cash generation ability to pay a decent dividend yield.

Hedge funds have been piling into this stock for the past quarter, adding 5.39 million shares to more than double their stake in the fast food giant. That brings hedge funds' total ownership in YUM to $541 million.

-- Written by Jonas Elmerraji in Baltimore.


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At the time of publication, author had no positions in stocks mentioned.

Jonas Elmerraji, CMT, is a senior market analyst at Agora Financial in Baltimore and a contributor to TheStreet. Before that, he managed a portfolio of stocks for an investment advisory returned 15% in 2008. He has been featured in Forbes , Investor's Business Daily, and on CNBC.com. Jonas holds a degree in financial economics from UMBC and the Chartered Market Technician designation.