* Hedge fund takes $3.5 bln stake, pushes for change
* Nestle shares up 4 pct, touch record high; L'Oreal up 4 pct
* Analysts see room to improve but say Nestle is cautious
* Latest proof that food companies are under pressure (Adds more background on Nestle)
LONDON/NEW YORK, June 26 (Reuters) - U.S. activist shareholder Third Point has targeted Nestle by taking a $3.5 billion stake in the food maker and urging Europe's most valuable company to boost returns as demand for its products weakens.
Nestle shares jumped as much as 4.8 percent on Monday, touching a record high after Third Point disclosed its position late on Sunday in a letter on its website that urged the Swiss group to improve margins, buy back shares and get rid of non-core businesses, including its stake in L'Oreal.
Despite the Nestle stake being only about 40 million shares -- or 1.3 percent of the total -- shareholders hoped it would spark change at a company which has a reputation for being slow-moving and insular.
"Nestle has arguably been lackadaisical and complacent and underperformed its potential," Bernstein analysts said. "It might now be stirred into action by an external force."
The stake is the largest ever taken by the New York-based hedge fund run by American investor Dan Loeb, which has pressed for change at U.S. internet firm Yahoo and Japan's Sony Corp .
It comes as Nestle and its packaged goods rivals grapple with slowing emerging markets, pressure on prices and consumers shifting from traditional brands toward healthier, fresher fare.
Nestle has missed its long-term sales target for four straight years, but so far has eschewed radical moves like Danone's $12.5 billion purchase of WhiteWave or Reckitt Benckiser's $16.6 billion Mead Johnson deal.
It has instead pushed slowly into healthcare, with a series of small investments and acquisitions that blur the boundaries of food and medicine.
The company, which is based on the shores of Lake Geneva and makes Nescafe coffee, Maggi noodles and Gerber baby food, said it was committed to its strategy under new Chief Executive Mark Schneider.
"As always, we keep an open dialogue with all of our shareholders and we remain committed to executing our strategy and creating long-term shareholder value," a Nestle spokesman said. "Beyond that, we have no specific comment."
One top-40 investor said Nestle has done a good job adapting over the years to a changing industry, selling its stake in eyecare company Alcon and buying pet food business Ralston Purina and Wyeth Nutrition.
"The pace of change may be too slow for some, but we would argue that it is better to be slow than to respond quickly to the demands of people who have only been on the share register for a few days or weeks," the investor said, speaking on condition of anonymity.
The move by Third Point cranks up pressure on Schneider, who joined in January just before the sector was rocked by Kraft Heinz's abortive $143 billion approach for Unilever . He has already been looking at ways to reignite growth since joining from German healthcare group Fresenius.
The first CEO from outside Nestle in nearly a century, his appointment was seen as an acknowledgement that Nestle needed new thinking. He has already scrapped the company's long-standing sales target and said it might sell its U.S. confectionery business, which includes brands such as Baby Ruth and Butterfinger.
Nestle had a market value of $263 billion on Friday, making it the biggest traded company in Europe. Monday's share price rise added another $10 billion to that figure.
The consumer goods sector, home to usually reliable sales and dividends, has seen its share of investor activism in the past with mixed results. Before Nestle, the latest big bet was the $3.5 billion stake in Procter & Gamble disclosed by Trian Partners in February.
Across the board, activists publicly targeted 37 European companies in the first four months of 2017, according to the most recent data from Activist Insight.
U.S. activist hedge funds have slowly cast their nets wider as corporate America becomes saturated with dissident shareholders seeking rapid changes to boost share prices.
"We feel strongly that in order to succeed, Dr. Schneider will need to articulate a decisive and bold action plan that addresses the staid culture and tendency towards incrementalism that has typified the company's prior leadership and resulted in its long-term underperformance," Third Point wrote in a letter to its investors.
It argued that Nestle should sell its 23 percent stake in French cosmetics firm L'Oreal, which was worth about $27 billion on Friday. L'Oreal shares rose 4.1 percent on Monday.
It also said Nestle should set a formal profit margin target of 18 percent to 20 percent by 2020 in order to help improve productivity. Nestle's current margin is 15.3 percent, below Unilever's 16.4 percent but higher than Danone's 13.8 percent.
Following its rejection of the Kraft bid, Unilever set a target to reach 20 percent margin by 2020, while Danone is targeting a margin in excess of 16 percent.
Third Point also recommended Nestle more than double its debt load, as well as sell the L'Oreal stake, in order to generate the capital to buy back stock.
Vontobel analyst Jean-Philippe Bertschy said Third Point's suggestions echoed proposals long made by other shareholders.
"Previous management was not too open to listen to critics," he said. "Now with Mr. Schneider, one of his top priorities was to improve shareholder communication and investor relations. I think he's listening carefully to what investors are saying."
Third Point's roughly 40 million shares in Nestle would make it the company's eighth-largest shareholder, according to Thomson Reuters data.
The stake is relatively small but Microsoft's experience with ValueAct Capital shows that public agitation from a small base can gain traction with other shareholders. ($1 = 0.8928 euros)
(Additional reporting by Simon Jessop and Maiya Keidan in London, Michael Flaherty in New York and Parikshit Mishra in Bengaluru; Editing by Mark Potter and Keith Weir)