5 Stocks With Bullish Sentiment From This Underrated Indicator

Meena is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Hedge fund sentiment is an underrated indicator of a stock’s bullish potential. At Insider Monkey, we’ve discovered strategies that retail investors have used to beat the market, and quite handily at that. Our small-cap strategy outpaced the broader indexes by 18% a year for more than a decade in our back tests, and since we started sharing these picks with the public, we've beaten the market by 18 percentage points in only five months (see how to capitalize on this strategy yourself).

Essentially, we’ve found that by tracking the best picks of the best hedge fund managers, it has, historically, been rewarding to pay attention to the smart money. One member of this group that often flies under the mainstream media’s radar is Dmitry Balyasny’s Balyasny Asset Management. Once called an “investor who crawled out of the woodwork” Balyasny’s Chicago-based fund has grown to one of the largest in the world, and is among the 450 hedgies we track (which comprises about 5% of the overall hedge fund industry).

Using Balyasny’s fourth quarter 13F filing from the SEC, we can determine what he and his investment team were bullish on heading into 2013. While it’s tempting to shrug off this data as delayed, our research has actually found that this delay helps piggyback investors, because on average, hedge funds are early into their investments (more about this phenomenon here). With that in mind, let’s take a look at Balyasny’s top five holdings.

Chicago Bridge & Iron (NYSE: CBI) is the hedgie’s No. 1 equity holding and has been so for two consecutive quarters. Balyasny originally formed his position in the third quarter, and since the beginning of this period, shares of the construction services provider have gained 37.5%. The hedge fund manager himself has said that “(we) focus on misunderstood situations,” and CBI definitely qualifies as one.

With a PEG of 0.9, the company is one of the cheapest players in the industrial goods sector, priced lower than about 90% of its peers. With earnings growth expected to accelerate by a modest amount over the next half-decade—20% compared to 16.5% annually over the past five years—it appears that Mr. Market is still undervaluing these prospects. It’s easy to see why Balyasny is bullish.

SM Energy (NYSE: SM) and Walter Energy (NYSE: WLT), meanwhile, are the second and third largest positions in the hedge fund manager’s portfolio, and Q4 marks the second straight quarter both energy companies have been in his top five. SM is an independent, onshore oil and gas operator, while Walter is a mid-sized producer of coal, predominately of the metallurgical sort.

SM’s primary bullish thesis lies in its ability to recoup with a natural gas recovery, and Walter is a similar bet on a coal rebound. It’s important to note that both stocks have gained double-digits (in percentage terms) over the past three months, and each trades at a decent valuation at the moment. If forced to pick, we’d rather have Walter at 11.5 times forward earnings and 0.7 times sales, but analysts do forecast SM’s EPS growth to average about 16% a year through 2017—over double that of what’s expected of Walter.

Penn National Gaming (NASDAQ: PENN) sits at fourth on this list. The casino and gaming property owner is up by more than 30% after announcing plans to spinoff part of its operations into a REIT structure. This has been a rewarding investment for Balyasny, who has held Penn since the first quarter of 2012. As one would reasonably expect, the hedgie’s peers have been piling into this stock of late, as the number of firms holding long positions jumped by 12% last quarter. Balyasny has quite the company in Penn, including Israel Englander, Mario Gabelli and Louis Bacon.

Whiting Petroleum (NYSE: WLL), lastly, rounds out this top five, as Balyasny upped his stake by 50% last quarter. The oil and gas E&P has already seen its stock price appreciate 11.3% year-to-date, as shares are on a similar trajectory as SM Energy’s. Like its industry peer, the sell-side expects growth to accelerate over the coming year, and the company actually trades at a more attractive 1.7 times book than SM’s 2.6x valuation. Wall Street’s average price target on Whiting indicates that an upside of 25% is possible from current levels, and with results like these, it’s always important to pay attention to the smart money.

This article is written by Jake Mann and edited by Meena Krishnamsetty. They don't own shares in any of the stocks mentioned in this article. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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