BALTIMORE ( Stockpickr) -- Love is in the air on Wall Street. Even though Valentine's Day is still months away, fund managers have been penning love letters to a handful of their favorite stocks in the last several weeks. Now, the question is whether it makes sense to fall for the pros' favorite stocks too.
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There's no question about it, funds' favorite stocks fell into two broad categories last quarter: the technology and finance sectors.
We know that because of their love letters to the broad market -- I'm talking about 13F filings. 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.
In total, approximately 3,800 firms file 13F forms each quarter, and by comparing one quarter's filing to another, we can see how any single fund manager is moving their portfolio around. While the data is generally delayed by about a quarter, that's not necessarily a bad thing -- research shows that applying a lag to institutional holdings can generate positive alpha in some cases. That's all the more reason to crack open the moves being made with pro investors' $20.5 trillion under management.
Interestingly, professional investors also took a step back from their defensive posturing in the most recent quarter, opting to pick up shares of two big IPOs. So, without further ado, here's a look at hedge funds' 5 favorite stocks.
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Up first is Alibaba Group (BABA) , a stock that broke new records when it went public back in September, raising $25 billion in the biggest IPO in history. Well, we now know who at least some of the buyers were: hedge funds. Alibaba was funds' single biggest new position last quarter, as fund managers added more than 398 million shares of this e-commerce name to their portfolios. That's a stake worth a whopping $35.36 billion as I write…
China-based Alibaba is the world's biggest e-commerce company. The firm operates a collection of marketplace websites with customers worldwide -- still, the firm's bread and butter is consumers in the People's Republic. Approximately one in five Chinese residents shops on an Alibaba site. Besides its namesake site, the firm's marketplaces include web marketplace Tmall, consumer-to-consumer sales site Taobao, and daily deals site Juhuasuan. Alibaba also operates the Alipay payment network, and a collection of smaller niche internet businesses.
Alibaba isn't particularly cheap here -- then again, that hefty valuation comes from BABA's big growth prospects. Investors are hot to get a piece of e-commerce growth in China, and Alibaba's market-leading position and U.S. listing makes it a no-brainer. And it's the no-brainers that everyone else needs to worry about. BABA is showing some technical cracks right now. Patient investors should wait for a more meaningful correction before following fund managers into this stock.
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Microsoft (MSFT) is proof that funds weren't just piling into new IPOs last quarter -- they're also building huge positions in established technology names in 2014. Funds added 66.98 million shares of Microsoft to their portfolios in the third quarter, a $3.25 billion add-on at current price levels. So, should Microsoft make your buy list this December?
Frankly, Microsoft has been no slouch in 2014. This $400 billion tech giant is up more than 29% since the calendar flipped to January, which means that it's outperforming the big S&P 500 index by a factor of three. Even though MSFT has been a firm in transition this year, its stable of cash-cow products has helped to smooth out any nasty performance surprises. Because Windows and Office still make up the lion's share of the firm's profits, Microsoft effectively has a subsidy as it explores other avenues. Nearly 60% of Microsoft's sales come from stable commercial sales and licensing.
From a financial standpoint, Microsoft is in excellent shape. The firm current carries $79 billion in net cash and investments, enough of a cushion to cover 20% of the firm's market capitalization today. Back out that cash, and MSFT's P/E multiple drops to a pretty tepid 14.4. That's a reasonably low valuation in an otherwise frothy market, and combined with Microsoft's momentum heading into 2015, it makes for an attractive buying opportunity here. I'd bet with the funds on this one.
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Social networking favorite Facebook (FB) is another tech name that's enjoyed outsized momentum in 2014 -- and it's another big stock that hedge funds have been buying with both hands. All told, fund managers picked up 83.73 million shares of the Menlo Park-based firm, enough to give it the number-three spot on our list of fund managers' favorite stocks. At current price levels, that's a $6.3 billion position hike.
Facebook is the world's biggest social network. More than 800 million users access their Facebook accounts each day, and they spend more time on the site than any other. Those factors give the firm a valuable audience, and its social angle gives it access to valuable data on its users. As Facebook works to better monetize that big user base, its in-depth intelligence on its users makes it an incredibly attractive ad platform for brands trying to market to targeted demographics.
Low costs and ad rates mean that Facebook doesn't need to do much improvement to materially move the needle. In other words, relatively modest improvements in ad serving can translate into some huge impacts on Facebook's bottom line. A perfect example of that is mobile, where Facebook had previously been a laggard, but has transformed into the premier mobile ad platform. That market opportunity is no secret, however, and Facebook trades for a large premium as a result. Despite a stratospheric earnings multiple, this is another name where momentum and a healthy business should be able to keep pushing shares higher in the intermediate term.
There are more attractive tech names on the market today, but there are worse ones too. It's not a bad idea to follow funds into FB this month.
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If Synchrony Financial (SYF) isn't a familiar name to you, that's because it didn't exist before this year. The banking firm was spun off from General Electric (GE) this summer, and renamed Synchrony. For some reason, General Electric Capital Retail Finance just didn't have the same ring to it for a retail bank.
But the new name is music to hedge funds' ears, at least. Last quarter, funds added 791.32 million shares of Synchrony to their portfolios, a $19.4 billion stake that adds up to nearly all of SYF's outstanding shares.
To the public, Synchrony Financial is another bank. But businesses know SYF as the largest provider of private label credit cards -- if you have a store-brand credit card, there's a very good chance that the credit was extended by Synchrony. The private label credit card business is attractive right now. For starters, cards are pushed hard by stores, offering big incentives for consumers who open new accounts. Stores like the captive nature of store-brand cards, and SYF likes the higher rates that it's able to charge for slightly higher-risk credit products.
It's unlikely we'll see interest rates rise in the near-term. Despite recent posturing from the Fed, target inflation numbers are reaching dangerously low levels (thus the intervention talk from central banks in Japan and the EU, for instance), and that means that SYF's credit spreads aren't likely to be affected by rising rates. Despite the recent IPO, this financial firm's valuation looks reasonable, and its product looks likely to keep growing in 2015 and consumers feel more comfortable spending. I'm betting with the funds on this stock.
Last up on our list of hedge funds' favorite names is pharmaceutical firm Actavis (ACT) . Funds added on 56.68 million funds during the most recent quarter, tacking on a massive $15 billion stake at current price levels. A big part of that outsized position hike came from the firm's $66 billion offer to buy Allergan (AGN) , a business-shaking move that throws a wrench in a hostile takeover attempt for Allergan from Valeant Pharmaceuticals (VRX) .
Unlike most pharma firms, expiring drug patents aren't a risk -- they're a boon. That's because Actavis is the third-largest generic pharmaceutical firm in the world, growing revenues when rival drugs lose patent protection and ACT can release its own off-label versions. The firm earns approximately 40% of its generic drug sales overseas.
In recent years, Actavis has been working to diversify its base beyond generics. It acquired Warner Chilcott last year, a deal that gives ACT exposure to higher-margin on-label drugs. Likewise, the Allergan acquisition adds a stable of attractive patented pharmaceutical brands to the firm's offerings. Ironically, Allergan's Botox brand is arguably one of the best examples of a well-marketed drug brand that can succeed commercially beyond patent expiration.
After some integration costs, expect the savings from a much bigger Actavis to work their way to shareholders' pockets. In the meantime, ACT's momentum looks strong. Investors could do worse than hedge funds' favorite pharma stock this December…
To see these stocks in action, check out the Institutional Buys portfolio on Stockpickr.
-- Written by Jonas Elmerraji in Baltimore.
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At the time of publication, author had no positions in the names 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 that 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.
Follow Jonas on Twitter @JonasElmerraji