Best Hedge Fund Investment Ideas (Part 1 of 5)

Every quarter, HypeZero offers 10 of the best investment ideas from the best hedge fund managers. These 10 ideas are generated by the HypeZero proprietary algorithm. The algorithm has been back tested since 2004 and has returned over 170% cumulatively. For the third quarter (August 15th to November 15th), Here are the 10 investments:

Apple Inc (AAPL: Nasdaq) ($631.69, August 14, 2012)

It’s no surprise that Apple tops the list of best investments. It is held by many of the best hedge fund managers including David Einhorn (Greenlight Capital), David Tepper (Appaloosa Management) and Julian Robertson (Tiger Management). In fact, over 13% of David Einhorn’s long portfolio is comprised of just Apple shares. Einhorn believes Apple is a business that offers a recurring revenue stream with a huge moat around its business.

“Despite its size, AAPL remains one of the most misunderstood stocks in the market. AAPL is a software company. The value comes from iOS, the App store, iTunes and iCloud. A Motorola RAZR phone was a one-time winner because when someone else made a phone that was just a little better, RAZR sales stopped. In contrast, a consumer with one AAPL product tends to want more AAPL products. Once the user has a second device, AAPL has captured the customer. At that point, a future competitor has to make a product that isn’t just a little better, but a lot better to get people to switch. The high switching cost makes AAPL’s business much more defensible than that of its predecessors.”

“Further, AAPL’s ability to consistently offer innovative features (as opposed to marginal improvements on the current features) encourages users to upgrade every couple of years. This provides a recurring revenue stream. And because AAPL embeds its software into its hardware, it doesn’t face Microsoft’s piracy problem. If the Chinese want AAPL, they have to buy AAPL. Rather than view AAPL as a hardware company, we see it as a software company that monetizes its value through the repeated sales of high margin hardware.”

If you back out the $120 cash and long term investments, even at today’s price $680, the company trades at around 13 times this years earnings estimate of $44/share. So, it is by no means overvalued. A lot of investors are frightened by the high stock price and the large market cap, but Apple is a great business at a fair price.

See below for full comments by David Einhorn in his 2nd Quarter letter to shareholders:

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Sears Holdings (SHLD: Nasdaq) ($55.17, August 14, 2012)

Sears makes it on the list thanks to Eddie Lampert (ESL Investments), who owns over 60% and Bruce Berkowitz (Fairholme Capital Management) who owns over 15% of its outstanding shares. In fact, Lampert just increased his stake by over 100 million on September 4th. The value case for sears has been nicely laid out by Fairholme.

Fairholme argues that if you sum up the different parts of Sears, they far exceed the market capitalization of the company. The major pieces are:

  • Real Estate: Sears holds prime mall based and other freestanding locations across the United States. These properties are either owned or leased long term for below market prices. Of course, the balance sheet does not accurately reflect the value of these assets.
  • Top Brands: Sears holds some of the top brands including: Kenmore, Craftsman, and DieHard. These brands were valued at $5.6 billion in early 2005.
  • Liquidity: Earlier in the year, there was some liquidity fears which made the stock crash to around $30. However, according the Fairholme the company had over $8.7 billion worth of liquid resources including $5.5 billion worth of net inventory.

With a market cap of just $6 billion, it is not hard to see why Lampert and Berkowitz love Sears and why the company has been buying over $1.5 billion worth of its shares over the last couple of years.

See below for Fairholme’s full case on Sears:

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This is part 1 of a part 5 series, please check back for part 2 later this week.

Disclosure: I do not own shares of AAPL or SHLD and do not plan to initiate a position within the next week.