Recent breakthroughs in artificial intelligence (AI) have investors fired up from Wall Street to Main Street. Namely, the intelligent chatbot ChatGPT from OpenAI provided concrete proof that AI could drive a step function increase in productivity, and its record-breaking rate of adoption points to tremendous demand for automation.
The AI boom is still in its nascent stages, but Nvidia CEO Jensen Huang says machine learning will be competitive with humans in five years, and many experts believe AI will be one of the most transformative technologies in human history. That hints at significant wealth creation.
In that context, AI is a once-in-a-generation opportunity for investors, and keeping tabs on successful money managers is one way to get inspiration. Here are two AI stocks hedge fund billionaires were buying in the third quarter.
1. Palantir Technologies: 183% year-to-date return
Data analytics company Palantir Technologies (PLTR 1.97%) has seen its share price soar 183% year to date. Here's a list of billionaire fund managers who started or added to positions in Palantir during the third quarter, and the number of shares they bought:
- Israel Englander (Millennium Management): 787,200
- Jim Simons (Renaissance Technologies): 3,805,496
- John Overdeck (Two Sigma Investments): 4,655,969
- Philippe Laffont (Coatue Management): 893,931
Palantir provides two primary data analytics platforms. Gotham was initially designed for defense and intelligence agencies, while Foundry was built for commercial customers. Both platforms integrate data and simple analytical models and sophisticated artificial intelligence (AI) models to create applications that improve decision-making.
Palantir not only supports model integration, but also the development and optimization of models, and it does so to great effect. The company is a recognized leader in ModelOps, a discipline concerned with model lifecycle management. Palantir is also a recognized leader in artificial intelligence/machine learning (AI/ML) platforms, and Wedbush Securities analyst Dan Ives recently referred to the company as "the gold standard in AI."
Palantir reported solid financial results in the third quarter. Its customer count increased 34% to 453, revenue rose 17% to $558 million, and generally accepted accounting principles (GAAP) net income improved to $72 million, up from a loss of $124 million in the prior year. Investors can expect similar momentum in the future.
The big data software market is forecasted to compound at 12% annually to reach $333 billion by 2027, but Palantir should grow more quickly due to its strong presence in the ModelOps and AI/ML platforms markets. Indeed, Morningstar analysts expect sales to grow at 23% annually over the next five years. That forecast makes its current valuation of 19.3 time sales seem somewhat reasonable.
The biggest problem with Palantir is revenue concentration. The company has a small customer base, so losing even a few customers could have a very big impact on the top line. Investors can buy a small position in this growth stock today, provided they understand that risk and keep tabs on the situation. But risk-averse investors should wait for a cheaper valuation.
2. Microsoft: 63% year-to-date return
Software and cloud giant Microsoft (MSFT 0.69%) has seen its share price soar 63% year to date. Here's a list of billionaire fund managers who started or added to positions in Microsoft during the third quarter, and the number of shares they bought:
- Andreas Halvorsen (Viking Global Investors): 1,822,348
- David Shaw (D.E. Shaw & Co): 1,459,352
- Ken Griffin (Citadel Advisors): 1,631,542
- Steve Cohen (Point72 Asset Management): 203,018
Microsoft has a strong presence in several enterprise software markets -- so much so that it accounted for 16.4% of software-as-a-service (SaaS) spending in 2022. The next closest competitor was Salesforce, with 8.4% market share. Microsoft has pivoted to a Copilot-focused growth strategy in software, hoping to capitalize on the growing demand for generative AI.
For instance, Microsoft 365 Copilot uses natural language to automate workflows across office productivity applications like Word, PowerPoint, and Excel. Similarly, Dynamics 365 Copilot leans on AI to automate workflows across enterprise resource planning applications ranging from sales and marketing to field service and finance.
Microsoft also has a strong presence in cloud computing. Azure accounted for 23% of cloud infrastructure and platform services spending in the third quarter, up nearly two percentage points from the previous year. One reason for those share gains is that Azure has "the best AI infrastructure for both training and inference," according to CEO Satya Nadella.
Additionally, Azure has an exclusive partnership with OpenAI, making it the only cloud vendor that offers access to OpenAI technology, such as the AI models that power ChatGPT and DALL-E. In other words, only Azure customers can use those models to build custom generative AI applications. That could draw more business to the platform in the future.
In short, Microsoft is leaning into AI across its enterprise SaaS and cloud computing products to cement its strong presence in both markets, and that seems to be a winning strategy so far. Microsoft delivered solid financial results in the most recent quarter. Revenue increased 13% to $56.5 billion, and GAAP net income climbed 27% to $22.3 billion.
The company should maintain a similar sales growth trajectory in the coming years, given that the enterprise SaaS and cloud computing markets are projected to compound at 14% annually through 2030. Additionally, CFRA analyst Angelo Zino believes Microsoft is the company "best positioned to monetize generative, given its ample offerings/pricing power."
In that context, its current valuation of 12.6 times sales seems relatively reasonable, though it is a premium to the three-year average of 11.4 times sales. Investors who are interested in owning this growth stock should start with a small position, then dollar-cost average should better buying opportunities present themselves.
