Following the "smart money" can be an effective investing strategy. Billionaires tend to employ savvy people to manage their money, and they often have an information edge.
That's not to say that the ultra-wealthy are clairvoyant or that they're not prone to most of the same mistakes that can affect the rest of us. Despite that, it's generally wise to listen when billionaires are sending clear signals like the one outlined below.
Hedge-fund trading data is a useful starting point
Hedge funds enjoy many investing advantages with billionaires, and many of them manage their assets. Goldman Sachs publishes reports on important trends in hedge fund holdings and transactions. This is useful data for determining the ways that sophisticated investors and the ultra-wealthy are thinking about markets and the economy at large.
Hedge funds were loading up on high-profile, large-cap tech stocks last year, driving the funds' exposure to the "Magnificent Seven" to an all-time high. Unsurprisingly, this coincided with massive outperformance by those stocks. Market capitalization-weighted tech ETFs have crushed equal-weight and total market index funds since the start of 2023.
To those unsure, in market cap-weighted funds, each underlying stock's contribution to the total value of the fund is determined by that stock's market cap relative to the aggregate market cap of all component stocks in that fund. For example, in the SPDR S&P 500 ETF Trust, Microsoft contributes nearly 7.1% to the fund's total value by virtue of its $3.1 trillion market capitalization, which -- as you guessed -- is nearly 7.04% of the aggregate market cap of the underlying stocks of around $44 trillion. (The percentages don't always match since the S&P 500 is rebalanced only on a quarterly basis.)
The below chart shows how tech ETFs outperformed their general peers. The Technology Select Sector SPDR ETF, the Invesco QQQ Trust, and the Vanguard Information Technology ETF, have all returned more than 60% since the start of 2023, while the more diversified SPDR S&P 500 ETF and the Invesco S&P 500 Equal Weight ETF have returned 34% and 17%, respectively, over the same period.
Data by YCharts.
Billionaires likely recognized the unique combination of quality, stability, and growth provided by tech giants amid uncertain macroeconomic conditions around the globe. The latest data from Goldman Sachs suggests that high-net-worth investors are taking some gains and selling positions in stocks like Microsoft, Alphabet, Apple, and Nvidia.
Those portfolio adjustments don't indicate a lack of confidence in the Magnificent Seven -- hedge funds' exposure is still high, even if they're reducing those positions. Instead, this is a reaction to the shift in the balance between risk and reward now that several of those stocks have delivered huge returns en route to all-time highs.
Shrewd investors are cashing out some of their positions and looking for the next big market movers among stocks with more attractive valuations.
Amazon (AMZN +0.20%) is a notable outlier from this trend, with hedge funds and billionaires disproportionately increasing their exposure to the e-commerce leader. The report from Goldman indicates that Amazon is now a top-10 holding for nearly 100 hedge funds, ahead of Microsoft, Alphabet, Nvidia, and Meta. The stock significantly lagged some of its peers last year, so investors seem to be focused on its relatively attractive valuation.
Given what we know about the most recent hedge fund trades, it's not surprising that Amazon shares are up 15% year to date, outpacing the Nasdaq Composite by roughly 8 percentage points.
Why you should be looking at Amazon
Investors might have fallen in love with the AI craze last year, but it's always important to never lose sight of business fundamentals. Amazon dominates an otherwise fragmented e-commerce industry with nearly 50% market share in the U.S. Its next closest rival, Walmart, holds less than 10% of online retail purchases.
It's likely that there will be future incursions from niche players enabled by the likes of Shopify, along with ongoing digital transitions from more-traditional retailers.
However, it's going to take a drastic shift to overcome Amazon's formidable economic moat. The company's sheer scale and superior technology and logistics allow it to provide unrivaled pricing and customer service.
Amazon Web Services (AWS) also leads in cloud infrastructure service, with 31% share. Microsoft has been closing the gap, but Amazon figures to be a key player in an important market for the foreseeable future. That market is expected to grow more than 15% annually, so that figures to be an important driver of growth and cash flow.
Amazon somewhat quietly delivered 14% revenue growth in its most recent quarter, with a good balance between North American and international markets. It also posted nearly 40% growth in its AWS segment. For all the concerns around enterprise growth and consumer strength, the company continues to churn out positive results.
The stock's forward price-to-earnings (PE) ratio is around 40, which seems a bit expensive, but its price-to-cash-flow (P/CF) ratio is under 20. It has a large gap between accounting profit and cash flow thanks to significant noncash depreciation, amortization, and share-based compensation expenses that get recognized on the income statement under generally accepted accounting principles (GAAP). You shouldn't ignore the GAAP profits. That methodology exists for a good reason, but it does obscure the true amount of cash that Amazon is generating each quarter.
Amazon has a sustainable competitive advantage, the potential to grow much more quickly than the economy in general, and is a cash flow powerhouse -- all available at a reasonable valuation. Billionaires have recognized these important factors, and retail investors should consider those merits, too.
