Money Matters - Simplified

5 Stocks the Hedge Fund Greats Love

 In 1993, Money World asked Warren Buffet what advice he'd give a new investment manager. "I'd tell him to do exactly what I did 40-odd years ago," Buffett said, "which is to learn about every company in the United States that has publically traded securities."

 

 The interviewer interrupted. "But there's 27,000 public companies."

"Well," Buffett replied, "start with the A's."

Impressive, but completely impractical for most of us. Rather than starting with the A's, mimicking the masters might be a more realistic approach to finding investment ideas.

Find out what the best investors are up to. Steal your ideas from them. Then dig a little deeper.

With the hedge fund tracking tool AlphaClone, that's what I set out to do. I used a composite index of several hundred of the world's most prominent hedge funds to see what stocks gained the most attention in the last quarter. In order, here's what I found:

1. Apple (Nasdaq: AAPL) 
Never mind that Apple is probably the most closely followed company on the planet. Never mind that its shares are up nearly 60% this year alone. Never mind, even, that company insiders have been selling lately. The hedge fund community still sees huge opportunity in Apple, and has put more new money behind the company than any other in the market.

The likely reason: A decent chance that Apple is still a good deal. Shares currently trade at about 14 times next year's earnings. Strip out the company's immense cash hoard, and valuations are even lower -- about 13 times projected earnings. Apple shares are up 350% over the past five years, yet earnings per share are up nearly 900% -- hardly a sign expectations are outgrowing reality.

2. Genzyme (Nasdaq: GENZ) 
Know what Genzyme is at this point: A takeover candidate with a board of directors fighting for every last dime. Sanofi-Aventis offered a hostile bid at $69 a share earlier this year. Management balked, suggesting $89 a share was more up its alley.

After shedding some non-core assets, Fool colleague Brian Orelli says Genzyme could be "slightly more attractive to potential bidders. Companies that aren't interested in the side businesses would have had to figure out how much they could sell the businesses for after the acquisition. Genzyme has done that work for them."

An exciting situation, indeed. But individual investors would be wise to steer clear. Merger speculation -- owning stock in a company that's been offered a buyout -- can be exceedingly dangerous. The upside is usually small, and the downside -- a dropped bid -- can slaughter investors in the blink of an eye. Yahoo! investors learned this the hard way in 2008 after a possible deal with Microsoft (Nasdaq: MSFT) fell through.

3. Citigroup (NYSE: C) 
Citigroup's allure can be tempting. Shares trade at well under one times book value, compared with a long-term average of over two times book value. Better yet, the yield curve is so steep these days that new loans are almost embarrassingly profitable. Borrow from the Fed at 0%, lend to the Treasury at 3%. Easy money.

But there are risks. Big banks might trade below book value because the market doesn't buy their managements' accounting practices -- hardly an irrational fear after the wholesale chicanery of the past decade. Another downside is that with the yield curve about as wide as it gets thanks to 0% interest rates, there's only one place it can now go: down. That risk could be somewhat allayed by an improving economy and lower default rates. With big banks plowing into Treasury securities in lieu of private loans, it's interest rates, not default rates, that could dictate future earnings.

4. PotashCorp  (NYSE: POT) 
PotashCorp. was just recently in a situation similar to Genzyme's described above. BHP Billiton offered to buy the fertilizer giant for $130 per share in August, which management promptly derided as "grossly inadequate."

Whether management was right doesn't matter any more. The deal fell through last week after BHP failed to achieve regulatory approval from the Canadian government.

What now?

With the deal nixed, PotashCorp shares should have fallen back to the level they traded at before the deal was announced, or about $100 a share. Instead, shares current trade for $143 -- even higher than BHP had offered.

There are a few explanations for this. One, the market might think a deal is still possible, either in a new bid from BHP or another buyer entirely. Two, the company's prospects could have improved substantially since August. In fact, competitor Mosaic (NYSE: MOS) has rallied 20% over the past three months without any buyout offers helping it along. Three, Potash Corp. shares could be grossly overvalued. The uncertainty abounds.

5. Qualcomm (Nasdaq: QCOM) 
"Qualcomm has patented the technology behind every 3G data network in the world," said Motley Fool tech editor Eric Bleeker. "If you want to use a phone that can connect to a modern data network, Qualcomm is profiting."

It's unusual to be sold on a stock in two sentences flat, but Eric essentially did just that with his recent recommendation of Qualcomm. Massive global boom in mobile devices; strong moat. That's a beautiful combo, bound to pay off handsomely.

© 2010 UCLICK L.L.C.