Many hedge funds delivered disappointing returns last year. The Eurekahedge Hedge Fund Index, which tracks the top hedge funds in the market, rose just 4.4% in 2016 -- underperforming the S&P 500's 11.2% gain.
The performance of individual funds varied greatly, but top investors like Warren Buffett noted that the market was saturated with too many hedge funds, and that their high fees made them poorer investments than basic index funds.
Nonetheless, investors still like to see what the "big boys" own, and BarclayHedge's third quarter report on hedge fund holdings reveals three well-known tech stocks are at the top of their shopping lists -- Apple (NASDAQ:AAPL), Facebook (NASDAQ:FB), and Amazon.com (NASDAQ:AMZN).
Forty-five of the top hedge funds owned Apple during the third quarter. That might seem surprising since the tech giant's iPhone, iPad, and Mac sales all declined annually last quarter, and analysts expect its revenue and earnings to respectively rise just 6% and 8% this year.
But despite those speed bumps, Apple still generated $52.3 billion in free cash flow over the past 12 months, held $20.5 billion in domestic cash at the end of 2016, and stashes over $200 billion overseas. This means that Apple could easily diversify away from its core hardware products by buying up more companies or investing in new projects.
Over the past 12 months, Apple repurchased $29.2 billion in shares and paid out $12.2 billion in dividends. That equals a yield of just 1.9%, but its payout ratio of 26% means that it could boost that payout to attract income investors. Apple's P/E of 14, which is lower than the industry average of 17, also makes it a safe value play in a volatile market.
Forty-three of the top hedge funds owned Facebook during the quarter. Facebook is a great growth play because it's the 800-pound gorilla of the social networking market and is disrupting Alphabet's business of traditional display ads.
Last quarter, Facebook's monthly active users (MAUs) rose 16% annually to 1.79 billion and its revenue surged 56% to $7.01 billion. Advertising accounted for 97% of its top line, and 84% of that came from mobile platforms. Its net income also surged 166% to $2.38 billion. With those robust growth figures in mind, Facebook's trailing P/E of 61 -- which is higher than the industry average of 50 -- doesn't look terribly expensive. Looking ahead, analysts expect its revenue and earnings to respectively rise another 52% and 80% this year.
But Facebook isn't resting on its laurels. It's still expanding into adjacent markets like virtual reality with Oculus and 360-degree videos, machine learning with a dedicated AI unit (FAIR), and even solar-powered drones for beaming internet connections to rural and low income regions. Those moves could all help Facebook grow beyond its core social networking and advertising business.
Forty-one of the top hedge funds owned Amazon, which dominates the e-commerce and cloud infrastructure markets. Over the past few years, Amazon expanded its e-commerce ecosystem with Prime, which locks in customers with free shipping, discounts, and digital perks. It's further expanded that ecosystem into homes with devices like the Kindle, Fire TV, Echo, Dash, and DRS-enabled appliances.
That's a low-margin business, but the higher profitability of AWS (Amazon Web Services) -- the biggest cloud platform in the world -- offsets those losses. Last quarter, AWS' operating income more than doubled annually to $861 million, which offset an operating loss at its international marketplace unit and boosted its total net income by 219% to $252 million. Analysts expect Amazon's earnings to grow 282% this year and 85% next year.
That's why analysts currently expect Amazon's revenue and earnings to respectively grow 28% and 282% this year. Based on those growth estimates, Amazon's trailing P/E of 185 and forward P/E of 93 don't look that pricey.
The key takeaway
Hedge funds often buy the same stocks because they're safe picks. They're more likely to buy Apple, Facebook, and Amazon instead of lesser-known small cap stocks with higher growth potential. That herd-like mentality is common on Wall Street, but I believe that these three stocks are still solid core holdings for any tech investor.
Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Leo Sun owns shares of Amazon.com. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Amazon.com, Apple, and Facebook. The Motley Fool has the following options: long January 2018 $90 calls on Apple and short January 2018 $95 calls on Apple. The Motley Fool has a disclosure policy.