2 Stocks Hedge Funds Own

It's been a brutal past few years for hedge funds, particularly those that focus on specific stock selection.  Though computer-driven, quantitative funds continue to gain assets, many of the world largest hedge funds have seen their assets decline and their performance lag that of the stock market benchmarks.

Still, many of the world's most powerful hedge funds remain a good source of ideas for retail investors. Sites such as WhaleWisdom mine and aggregate the 13-F filings of the world's largest asset managers to help identify what institutional investors around the world are doing best.

Before delving into our analysis, though, a word of caution. Hedge funds and other sophisticated investors can quickly move in and out of stocks, so the figures you're seeing here might not reflect the current composition of their portfolios. Moreover, any individual holding can represent just one piece of a more complex trade. So investors need to use this list only as a jumping-off point for future research.

Now, following up on my earlier analysis on this topic, let's consider why many of the world's largest hedge funds and institutional money managers invest in shares of Charter Communications (CHTR 0.69%) and Microsoft (MSFT 1.74%).

Charter Communications

After a historic 2016, shares of newly minted national cable giant Charter Communications have slightly outpaced the market so far this year. The acquisition machine is a top-10 holding of 74 large institutional investors, including Warren Buffett's Berkshire Hathaway and Lone Pine Capital. Having absorbed last year's acquisitions of BrightHouse Networks and Time Warner Cable, the company will need to make good on its new scale to continue to push its stock higher. That might be difficult to achieve, for a few reasons.

So far, the company has received mixed marks for its post-merger execution. On the positive side, Charter has increased its total number of customer relationships in recent quarters. However, it's the composition of that growth that concerns me. Though it continues to add broadband and voice-phone users, the company's cable-subscriber numbers continue to decline; it lost 51,000 video customers in Q4 2016 and another 100,000 in Q1 of this year. The company is in the midst of launching a wireless partnership with Comcast, though some of my colleagues view this as an incremental change at best. If the trend continues, we could see Charter's average revenue per user, an important cable and wireless industry metric, start to decline.

Moreover, the company's substantial debt burden is a concern. Charter's debt-to-equity ratio is 1.25, and its interest coverage ratio is 0.85. That alone won't sink the company, but Charter will need to prioritize strengthening its financial footprint in the coming years -- which could inhibit its ability to develop new products.

Microsoft

It's been a good time to hold Microsoft stock. Its shares, a top holding of more than 800 money managers, have outperformed the Nasdaq Composite benchmark 36.9% to 26.9% over the past 12 months.  However, although Microsoft makes sense for some types of investors, especially those seeking income from their investments, I don't agree with the hedge fund industry's bullish stance.

The consensus sell-side rating labels Microsoft a buy, so maybe I'm overlooking something, but Microsoft doesn't strike me as a tantalizing value. The company currently trades at 31.1 P/E, well above the S&P 500's 25.7. Contrast this valuation against analysts' current growth estimates for Microsoft's next two years:

Data source: Yahoo! Finance 

For a company likely to put up just moderate growth, Microsoft's premium valuation seems out of whack.

The company is executing around its potential growth drivers under CEO Satya Nadella. The Azure cloud-computing platform's revenue grew by 113% from fiscal 2015 to fiscal 2016, for example. However, Microsoft remains so dependent on Windows and Office, especially in terms of their impact on profits, that it will be difficult to drive meaningful growth over the long term.

So while Microsoft can be great dividend stock and hedge funds seem to love it, I'm not as sold that it has the makings of a long-term market beater, given what we know about it today.