5 Best Innovative Stocks To Buy According To Hedge Funds

In the first part of this article we explained that we are on the cusp of huge transformational technological changes and investors can generate huge returns by investing in the companies that will shape the future. The tricky part is identifying these companies in advance. For this we started with the top 50 holdings of ProShares MSCI Transformational Changes ETF (ANEW)  and ranked those 50 stocks using Insider Monkey’s hedge fund sentiment data to identify the 15 best innovative stocks to buy according to hedge funds.  Below we presented the 5 best innovative stocks. For the complete list please see 15 Best Innovative Stocks To Buy According To Hedge Funds.

5. Visa Inc (V)

Number of HFs: 160

Value of HF Holdings: $18.7 billion

Rank in ProShares MSCI Transformational Changes ETF (ANEW): 29

Weight in ProShares MSCI Transformational Changes ETF (ANEW): 1.37%

Visa is one of those stocks that never gets cheap enough for value investors to buy, yet the stock reaches a new high year after year. For example, Horizon Kinetics compared Visa to Facebook in its 2019 Q3 investor letter. Visa’s 3-year revenue growth rate was 13.9%, vs. Facebook’s 31.2%, yet Facebook’s PE ratio of 29.6 was lower than Visa’s PE ratio of 32.5. The implication was that Facebook is cheaper than Visa, but this doesn’t mean that Visa will be a bad investment for investors.

Here is why Qualivian Investment Partners believes Visa will continue to compound at high rates:

“Visa: was a positive contributor in the quarter, just less so than our other holdings. Visa’s fiscal Q4 quarter (calendar Q3) results were better-than-expected as revenue and EPS beat street expectations driven by stabilizing domestic transaction volumes and good expense control. Although results showed continued pressures from depressed cross border volumes, which may continue for the foreseeable future as with MA, we believe the worst is behind us and our long-term thesis of V’s structural positioning on the other side of the pandemic remains intact. Looking to the back half of 2021 and going into 2022, we see a recovery in cross-border activity, which together with traditional spending improvements at the POS, leaves considerable room for upside upon reopening. Further, once the macro normalizes (medium term), we believe V (and MA) will continue to benefit from structural drivers including increased contactless payments, more eCommerce transactions, as well as a lift in the value-added services like fraud/gateway/marketing services, and demand for other flows such as B2B, G2C and use of Visa Direct. There is no credible competition on the horizon for the Visa/Mastercard payment networks.”

4. Alibaba Group Holding Ltd (BABA)

Number of HFs: 166

Value of HF Holdings: $28.8 billion

Rank in ProShares MSCI Transformational Changes ETF (ANEW): 17

Weight in ProShares MSCI Transformational Changes ETF (ANEW): 1.83%

China has become a leader in innovation and it has one of the most advanced online markets in the world. We have no doubt that Chinese economy will become the largest economy in the world over the next 10 years or so. This isn’t a very long time period. It is coming. It is likely that Alibaba will become bigger than Amazon. However, Alibaba faces bigger competition than Amazon and it is subject to significantly more political risk than Amazon. That’s probably why it is much cheaper than Amazon and that’s why it declined recently.

Third Point said the following about Alibaba in its 2020 Q2 letter:

“As we have articulated in prior letters, our outlook for Alibaba and the broader Chinese e‐commerce market is bright. We believe online gross merchandise value (“GMV”) will grow at a mid‐teens CAGR over the next five years, propelled by both (1) rising consumption per capita, as the Chinese retail market is equal in size to the U.S. despite four times as many consumers, and (2)increased penetration of retail by online, a trend which we believe has been structurally accelerated by the COVID‐ 19 pandemic. As the e‐commerce market matures, we believe Alibaba & JD will leverage scale and growing repositories of transaction data to increase monetization of their platforms through targeted advertising to improve revenue yields (revenues as a percentage of GMV) from a starting point of less than 4% today. As a point of comparison, brick‐and‐mortar retail store rent expenses in China are greater than 10% of sales on average, which provides a significant umbrella for online marketplaces to take a greater share of GMV through a combination of commission and advertising spending as online retailer cost structures converge with brick‐ and‐mortar retail.

Finally, we continue to be excited about the latent potential in some of Alibaba’s businesses beyond the core e‐commerce marketplaces – particularly the cloud computing business, Aliyun. China’s cloud computing industry remains nascent but is growing nearly 3x faster than its developed market counterparts through a combination of rising IT intensity, rapid cloud penetration, and a gradual moderation in software piracy. Within that market, Aliyun is increasingly dominant (with nearly 50% market share) and will generate dramatic profit growth as margins expand with scale. As one reference point, Aliyun today resembles Amazon’s AWS business five years ago; this is an encouraging comparison given that today, AWS’ operating profits (and estimated enterprise value) exceed Alibaba’s business in its entirety. Ant Financial – in which Alibaba holds a ~30% stake that is worth roughly $70 billion – has announced its intention to go public later this year. Alibaba shares will benefit further should they become accessible to mainland Chinese investors through inclusion in the Southbound Connect.”

3. Facebook Inc. (FB)

Number of HFs: 230

Value of HF Holdings: $29.3 billion

Rank in ProShares MSCI Transformational Changes ETF (ANEW): 21

Weight in ProShares MSCI Transformational Changes ETF (ANEW): 1.77%

Facebook is another technology company that has a finger in many pies. One of the most exciting projects Facebook is involved in is its digital currency. Facebook’s main business of selling advertisements seems to be recession resistant. Here is what Wedgewood Capital said about it in its 2020 Q3 investor letter:

“Facebook’s revenues grew +12% constant currency despite the near total shutdown of economic activity during the month of April. The vast majority of Facebook’s revenues are derived from small businesses, many of which have borne the brunt of lockdowns. To combat the sudden disappearance of foot traffic, these businesses are initiating or accelerating the adoption of digital customer acquisition strategies provided by Facebook’s vast ecosystem, including instant access to over 2 billion daily users. We continue to carry Facebook as one of our largest holdings as its value proposition is difficult to copy, yet the stock trades at still somewhat reasonable multiples relative to large cap peers,”

2. Microsoft Corporation (MSFT)

Number of HFs: 234

Value of HF Holdings: $42.1 billion

Rank in ProShares MSCI Transformational Changes ETF (ANEW): 9

Weight in ProShares MSCI Transformational Changes ETF (ANEW): 1.95%

Wedgewood Partners said the following about Microsoft:

Microsoft’s sprawling software and services portfolio has sustainable competitive advantages and durable long-term growth prospects, combined with more reasonable valuation as the stock has sold off from its all-time highs due to COVID19 disruptions. Although the Company ended the quarter at a +9% weighting in the Russell 1000 Growth Index benchmark, we still believe Microsoft is a worthy destination for our clients’ portfolios on an absolute basis.

Microsoft has a formidable position in productivity software, with between 80% and 90% market share, thanks to the multi decade dominance of Microsoft Office in both commercial and personal end markets. Over the past several years, a substantial portion of the Office installed base has converted from perpetual licenses to subscriptions, yet a still meaningful amount of Microsoft Office revenue remains on perpetual terms. We estimate Office 365 subscriptions could generate a two to three times uplift in revenue per user and add an incremental $20 billion in revenue if Microsoft can manage to phase out perpetual licenses over the next several years. In addition, with a cloud-based delivery model, the Company can quickly develop and add new products and services to the Office 365 suite and monetize by adding higher pricing tiers – rather than waiting years at a time for a new product cycle for on-prem deployments. Microsoft’s newfound ability to quickly develop products, helps maintain its position in the productivity market, despite smaller, fast moving competitors. For example, Microsoft Teams is the Company’s business communication platform that was developed internally over the past few years and officially launched in 2017. Teams has already amassed over 44 million active users to date, with 12 million of those users joining in just the past few weeks, as they seek work from-home solutions. Microsoft’s ability to develop and deploy quickly should allow the Company to continue to be in the right place at the right time.

Microsoft has done an excellent job entrenching its position as a mission-critical provider of infrastructure software and services, especially with its Azure cloud platform. Businesses continue to move more workloads onto infrastructure as a service (IaaS) platforms, as IaaS enables more IT flexibility and has lower capital commitments, relative toon-premises hardware and perpetual licenses.

1. Amazon.com Inc (AMZN)

Number of HFs: 245

Value of HF Holdings: $43.8 billion

Rank in ProShares MSCI Transformational Changes ETF (ANEW): 13

Weight in ProShares MSCI Transformational Changes ETF (ANEW): 1.88%

Amazon is by far the most popular stock ever among hedge funds. We have been tracking this measure for 10 years and we have never seen a stock that is owned by more than 30% of all equity hedge funds. If you aren’t familiar with how Amazon became a $100 billion in revenues/quarter company, please read our article “How Amazon Makes Money“. Light Street said the following about Amazon in its 2020 Q1 investor letter:

During this crisis, the Internet has become the core operating system of our partially shuttered economy. eCommerce and logistics businesses like Amazon, UPS, FedEx, Uber Eats, DoorDash, Grubhub, and Instacart are now the backbone of the U.S. economy. Light Street’s largest position is in Amazon. Demand for food and home goods is exploding. People are nesting at home, adjusting to the new realities of working from home, and purchasing furniture and apparel to make the best of it. In-home entertainment services are flourishing, including streaming video and gaming, where Light Street is long Netflix and Activision respectively.

Soma Equity Partners agrees with Light Street:

Amazon is poised to take the reigns as the world’s largest company and may never look back. The COVID-19 crisis is accelerating the adoption of online shopping around the world. Online grocery is hitting a notable inflection, with surveys indicating as high as 55% of consumers now buying online. Amazon Grocery is poised to more than triple from a $20 billion segment in 2019 to $80 billion by 2023. Amazon’s central role in our lives is perhaps best demonstrated by the adoption of Amazon Prime. Almost three in every four households in the U.S. are now members, approaching 90 million in total. We acquired our first ever AMZN stake in March near $1,800 per share, representing the only sizable new long we entered during the sell-off. While we typically look for more contrarian positions, we felt particularly motivated by a 20% discount on the company with the biggest stack of chips in the market. The optionality that comes with Amazon’s scale, including deeper forays into media, logistics, and overseas markets, should provide tailwinds to the stock for years to come.

You can read Third Point’s AMZN comments in its Q2 letter here.

Please also read 11 Best Lithium and Battery Stocks To Buy and 15 Best Technology Stocks To Invest In.

Disclosure: No positions.