The Crisis Survivors

 | Aug 28, 2013 | 5:00 PM EDT
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Many market watchers refuse to allow hedge funds' quarterly 13F filings with the Securities and Exchange Commission to play any role in their own investment processes, arguing that it's impossible for such old information to be of any use. Through careful testing and research, however, we've proven this common view wrong. The most popular small-cap stocks among hedge funds tend to outperform the S&P 500 by an average of 18 percentage points per year. Our portfolio following this strategy has returned 33 percentage points above the index in the past 11 months, and we believe that more techniques are possible.

And that's not all. Our database comes in handy for reviewing hedge funds' most popular stocks in a number of areas, from specific industries or sectors to stocks satisfying various criteria, including stocks that are low risk in the sense that they don't do too poorly when market conditions are poor.

To follow are the five most widely owned stocks among hedge funds that have fallen in price by less than 10% in the second half of 2008, the height of the financial crisis (for comparison's sake, the S&P 500 was down by roughly 30% over that time frame).

Among the filers we track, Pfizer (PFE) was the top pick in this category, actually increasing in price by 1% in the last six months of 2008. The mega-cap pharmaceutical company currently has a dividend yield of 3.4%, making it a potential pick for either income or defensive investors. Bulls argue that Pfizer, following its ongoing sales and spinouts of non-core businesses, will improve operations and profitability. With the stock valued at only 12x forward earnings estimates, it's worth looking at.

Another large pharmaceutical company that satisfies our criteria is Gilead Sciences (GILD). The company's stock price has more than doubled in the last year, to a market capitalization of $90 billion, and this appears to be entirely due to investors' high expectations for future growth. Wall Street analysts are projecting increases in earnings per share, and, as a result, the stock's trailing and forward price-to-earnings ratios are 33 and 20, respectively. Gilead's sales rose by 15% in the most recent quarter compared with the second quarter of 2012, though it's worth nothing that net margins shrank a bit, so profits grew by only 9%.

Also sporting decent defensive credentials -- down by only 7% between July and December 2008 and, more generally, featuring a beta of 0.5 -- is Johnson & Johnson (JNJ), which was owned by 64 funds at the end of the second quarter. At current prices, the healthcare company pays a dividend yield of 3%. While its trailing earnings are not too attractive, business has been growing. Revenue was up 9% in the second quarter of 2013 vs. a year earlier, and with the sell-side expecting continued improvements, the forward earnings multiple is reasonable at 15.

Procter & Gamble (PG), like Pfizer, was actually up sharply in late 2008 as markets plunged. The personal products company pays a 3% yield, in line with what we saw at Johnson & Johnson, and is, of course, a large blue chip stock with a market cap of more than $200 billion. P&G's fiscal year ended this past June, and during its fiscal fourth quarter, the company's revenue actually decreased slightly compared to the same period in the previous year. Analysts expect a recovery, though we would avoid the stock for now on the combination of valuation and performance.

Finishing off our list of crisis survivors (which hedge funds love) is Actavis (ACT). The generic drug company has pursued an acquisition of Warner Chilcott (WCRX), which will allow Actavis to relocate to Ireland and save on taxes as higher sales pull its pretax income higher. Beta is low, even by Big Pharma standards, at 0.2. The forward P/E is only 14, which is low enough to merit consideration by value investors.

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