Using Institutional Ownership to Choose the Best Stocks

As an NBA fan, I posed the following question to one of our new traders: Suppose I am very good at using statistical data to predict the results of NBA games. Suppose I use this skill to try to predict the outcome of one such NBA game.

My results use all relevant data that has proven itself throughout history. However, after my work was done, I saw a very big discrepancy between what my analysis predicted and the betting lines for the game. What should I do?

A)  Bet my analysis
B)  Do nothing

The answer, at least to me, after decades of following NBA games, is obvious – B) Do nothing.

The reason is not actually because my analysis is wrong; the reason is that my analysis uses average statistical data for players. My analysis assumes that players are available and capable of producing at their average rate.

However, if a player has been injured and has not recovered completely, his expected production rate can be lower, sometimes much lower than the historical averages. And betting lines usually incorporate that much better and faster.

Chances are line setters also use analysis similar to the one I use, but they also have experience with injury recovery times. Unreported or underreported injuries of NBA players are the biggest killers of basketball analytical predictions.

Understanding Institutional Ownership – Examples in Action

Let’s see if we can incorporate that analysis into stock predictions. Everything is based on valuations (our analysis or stock analysts’ expectations), so how do we compare it to stock betting lines?

The answer could be a bit surprising but the logic is the following – if a stock has above average institutional ownership rate, usually that analysis is widely believed by informed market participants (bookies here are institutions) and if that institutional ownership is low, that analysis is not trusted by informed participants and there is a good chance it will not occur.

So, the question is – what is average institutional ownership, and where do we find it? It is our experience that the average institutional ownership rate is low at 70%, and we use yahoo.com or finviz.com to find the exact number.

1) JPMorgan Chase & Co. (JPM)

As an example, we will use JPM because everything is more accessible with an actual example:

Data extracted from a Finviz page indicates that JPM exhibits an institutional ownership rate of 70.80%, with a slight increase of 0.11% recorded over the last six months. Let’s use those statistics and see how it compares among different stocks.

2) Alibaba Group Holding Limited (BABA)

Let’s start with one of the cheapest ones – BABA. BABA has a PE ratio of 18 and a forward PE ratio of 9 (much lower than most S&P 500 stocks). Sure, it does look attractive.

However, the institutional ownership rate is 15% and has decreased by 10% over the last six months. Nobody believes that valuation is attractive – at least nobody amongst institutional investors. Of course, that could change, but in our opinion, BABA could very well be a value trap.

3) NVIDIA Corporation (NVDA)

Moving on to a stock that is not so cheap – NVDA. NVDA, according to Finviz is trading at PE of 62 and a forward PE ratio of 32 (both above market multiples).

The stock has been performing quite well and with a price above 1000  USD one would think that this is precisely the stock only institutional investors would own but that is incorrect – institutional ownership rate is at 65% (practically unchanged over the last 6 months).

The 65% rate is below average rate but not alarmingly below average. While the CEO of NVDA sees no slowdown is orders, according to his own words during the most recent post earnings interview, many institutional investors believe he will see it soon.

4) Berkshire Hathaway Inc. (BRK-A & BRK-B)

Moving on to BRK. Mr. Buffett has one of the best investment records the world has ever seen; however, as we pointed out in one of our recent publications – Berkshire Hathaway in no longer a market beater, the record has been quite pedestrian over the last 20 years.

The institutional ownership rate of BRK-B is only 40%, while BRK-A is a dismal 8% rate. Yes, hardly any institutional investors believe that Mr. Buffett will beat the S&P500 at the age of 90.

5) UnitedHealth Group Incorporated (UNH

Lastly, we will seek an example of above-average ownership – UNH. UNH is trading at 16.50 forward PE (30% lower than S&P500). That certainly makes its valuation cheap.

Moreover, institutional ownership rate is nearly 90% and has stayed stable over the last 6 months.

Yes, UNH is looking cheap and most institutional investors think so too. In conclusion we will say we believe that institutional ownership rate is one of the most underutilized easily available statistics. It is not perfect nor guaranteed to work out, especially when deviations are less than dramatic.

For example, the institutional ownership rate of NVDA is not that different from that of JPM.

Setting the Bar

In conclusion we will say we believe that institutional ownership rate is one of the most underutilized easily available statistics.

It is not perfect nor guaranteed to work out, especially when deviations are less than dramatic. For example, the institutional ownership rate of NVDA is not that different from that of JPM.

Most stocks in the US have institutional ownership rates between 50% and 90%.

We would prefer a stock has an institutional ownership rate above 80% before we buy it but even if it is 50% or 60% we will still buy, as long as valuation is low. Again, we would prefer it is 80% institutional ownership rate and we will double check our valuation but as long as rate is above or near 50% we will usually proceed.

Where we draw the line is if institutional ownership is significantly below 50% and there are quite a few stocks that are like BABA where institutional ownership is even below 20%. We would just stay away from them, regardless of the valuation.

Disclaimer