One common misconception about hedge funds' quarterly 13F filings is that because this information is old (the most recent filings disclose many long equity positions as of the end of June), it is useless for investors. Not so. Our research has shown that the most popular small-cap stocks among hedge funds earn an average excess return of 18 percentage points per year, and our own portfolio based on this strategy has outperformed the S&P 500 by 33 percentage points in the last 11 months.
We believe that using hedge funds' picks as a screen of stocks in a number of areas, including dividend stocks, and then doing further research on any interesting names, can also be useful, although it's tough to quantify any additional returns that investors might see. Read on for our quick take on the five largest positions in billionaire Glenn Dubin's Highbridge Capital Management's most recent 13F portfolio which currently pay dividend yields of 3% or higher.
Dubin and his team increased the size of their position in the pharmaceutical company Abbvie (ABBV) to a total of 1.1 million shares. Abbvie has a $68 billion market cap and trades at 13x trailing earnings, whether we compare that valuation with its trailing results or with Wall Street analysts' expectations for 2014. At quarterly dividend payments of $0.40 per share, the stock's yield is 3.7%, which is fairly high even for a large drug manufacturer. Both revenue and operating income were up slightly in the second quarter of 2013 from a year earlier, so at current prices it could be a value prospect.
Highbridge cut its stake in Pennymac Mortgage Investment Trust (PMT) but still closed June with 2.1 million shares in its portfolio. As a real estate investment trust, Pennymac receives favorable tax treatment that is conditional on distributing a large share of taxable income to shareholders. REITs therefore often pay high yields, and Pennymac's is quite high at over 10%. However, this yield reflects the risks inherent in the company's business: Pennymac invests in residential mortgage loans, and many similar companies encountered significant difficulties during the recent financial crisis and recession.
The fund was buying Verizon (VZ) last quarter, making the large telecom another of its dividend picks, given that stock's annual yield of 4.3%. Revenue grew by 4%, according to Verizon's last quarterly report, compared with the second quarter of 2012, and since margins are expanding as well, this resulted in an impressive growth rate on the bottom line. The sell side expects good results to continue next year, and in fact, Verizon looks reasonably priced at a valuation of 15x forward earnings estimates. As with many large telecoms, it is also a quite defensive stock, having a beta of 0.2.
The 13F shows that Highbridge had a little over 400,000 shares of McDonald's (MCD) in its portfolio at the beginning of July. Another classic defensive pick, this quick-service restaurant features a beta of 0.2 and a dividend yield of a little over 3%. Recent reports show only modest growth, however, and the trailing and forward P/Es are 17 and 16 respectively. While those multiples represent a discount to the stocks of many other quick-service restaurants, on an absolute basis they make McDonald's look a bit pricey to us. As a result, we would avoid it, at least for now.
Eli Lilly (LLY) rounds out our list of Dubin's favorite dividend stocks; the filing disclosed ownership of about 780,000 shares. While the pharmaceutical company's net income has been up recently, analysts believe that this is only temporary, and they are calling for earnings per share of $2.77 in 2014. This makes for a forward earnings multiple of 19, and so Eli Lilly would have to rebound from these results with moderate to high growth rates. At current prices and dividend levels, the yield is 3.7% -- the same level as that of Abbvie.