In this piece, we will take a look at the 10 best consumer cyclical stocks to buy now.
Consumer cyclical stocks are highly correlated with the economic cycle. Ideally, you’d want to buy them near the bottom of a recession when their prices are lower, anticipating a recovery and rising consumer spending. Essentially, owning consumer cyclical stocks is a bet that the economy will be growing in the near future. This is in contrast to consumer staples, or consumer defensive, stocks which allow investors to position their portfolio to hedge losses in the case of an economic downturn.
Since consumer cyclical stocks are riskier than their defensive counterparts, they offer higher returns and also come with the corresponding increase in risk. Additionally, while determining the risk of consumer defensive stocks might be relatively easy and off the bat calculations can be used, conducting the same exercise for cyclical stocks is trickier. Investors determine a stock’s risk by calculating its beta (β), which measures the tendency of a stock to move with the broader market. Stocks with a β greater than one are more volatile, those with a β less than one are less volatile, and a few (like gold mining stocks) can even have a negative β that makes their share prices move in opposition to the market.
So why is measuring the risk of cyclical stocks tricky? Well, research shows that investors can either rely on a ‘reasonable’ β estimate of 0.7 for defensive stocks or narrow them down by stock sector to define a β that ranges between 0.6 to 0.8. On the flip side, similar shortcuts are unadvised for calculating the β for consumer cyclical stocks. To determine the risk of these stocks, a case by case approach that takes into account the earnings volatility of a firm and the overall business model is recommended.
Building on this, consumer cyclical stocks are dependent on the business cycle for their performance. In fact, data shows that if you’re able to time the business cycle, then investing in consumer staples stocks can provide an opportunity to lead all other market sectors in terms of return. The business cycle is broadly divided into four phases, the early, mid, late, and recession phases. Each phase is marked by unique economic characteristics, and research shows that consumer cyclical stocks perform the best during the first phase. This phase marks the start of a new business cycle after the previous cycle’s recession phase has ended, and its biggest traits are low interest rates and an uptick in economic activity.
Research shows that the first phase of the business cycle is the one that features the highest sector differentiated performance, with the difference between returns spreading to 25 percentage points. The stocks that lead the returns in this period are consumer cyclical stocks since lower interest rates and an uptick in economic activity allow consumers to have higher discretionary spending and enable businesses to expand operations through easy credit. The ‘hit rate’ (which measures the percentage of time periods in the business cycle periods in different cycles over time where the sector outperformed) of cyclical stocks during the early phase is 100%, which ties in with the performance of consumer staples in the late stage among all seven stock market sector performance across all phases of the business cycle. In terms of average returns, consumer cyclical stocks return roughly 12% as a category, implying that individual stocks will offer higher returns as the data is influenced by outliers to a large extent.
Since consumer cyclical stocks are dependent on business cycles to a large extent and also rely on robust consumer spending, the next step in analyzing their performance is to see how spending varies within the cycle. Estimating what stage of the business cycle we’re in is a tricky process, and analysts at the investment bank Morgan Stanley have tried to do so. Their research shows that we are currently in the downturn phase of the cycle, which precedes the early stage we’ve talked about above. We can also try to determine the business cycle’s stage ourselves. Right now, inflation is still trending above trend in America (2.6% PCE in May vs 2% preferred), first quarter GDP growth slowed down (1.6% in Q1 from 3.4% in Q4 2023), and inventories at retailers jumped by 1% annually in February. These three metrics suggest that we might be in the late stage of the business cycle which typically precedes a recession. Consumer spending slows down in the late stages of the business cycles, the downturn and the recession, and neither cycle stage bodes well for consumer cyclical stocks. A key indicator of consumer spending is consumer confidence as it indicates future economic perceptions. On this front, US consumer confidence in March, April, May, and June stood at 103.1, 97, 101.3, and 100.4, respectively. A lower value signals lower confidence, and a value under 80 can signal a recession.
Topping our analysis, let’s take a look at how consumer cyclical stocks have recently fared to check whether the conclusions we’ve reached above are supported by stock market performance. As a refresher, 2024 has been characterized by investors pushing forward interest rate cut expectations and seeking shelter in a few stocks characterized by their strong exposure to the artificial intelligence industry. Two of the most popular consumer staples and defensive stock indexes are those managed by the S&P. Looking at their performance over the past twelve months, these are up by 14.8% and 5.8%, respectively. This is unsurprising since the US GDP has defied expectations during this time period, as it grew by 4.9% and 3.4% in Q3 and Q4 2023 and beat analyst expectations.
However, Q1 2024 GDP growth slowed down to 1.6%, which not only missed analyst estimates of 2.4% but also came with some rather ill-boding expectations for consumer cyclical stocks as spending growth slowed down from its 3.3% growth in the previous quarter to 2.5% in Q1. This figure also sat well below Wall Street’s 3% estimate. The data was released in April, and the previous release which saw the 0.4% inflation reading for March outdo analyst estimates triggered a 6% drop in the consumer cyclical stock index over the next nine days. Since then, the index has gained 6.57%.
With these details in mind, let’s take a look at some top consumer cyclical stocks.
Pixabay/ Public Domain
Our Methodology
To select the best consumer cyclical stocks to buy, we ranked the 40 biggest consumer cyclical stocks in terms of market capitalization stocks by the number of hedge funds that had held a stake in them during Q1 2024. Why are we interested in the stocks that hedge funds pile into? The reason is simple: our research has shown that we can outperform the market by imitating the top stock picks of the best hedge funds. Our quarterly newsletter’s strategy selects 14 small-cap and large-cap stocks every quarter and has returned 275% since May 2014, beating its benchmark by 150 percentage points (see more details here).
10. The Home Depot, Inc. (NYSE:HD)
Number of Hedge Fund Investors In Q1 2024: 70
The Home Depot, Inc. (NYSE:HD) is one of the biggest home improvement products retailers in the US. While most retailers are classified as consumer defensive stocks, The Home Depot, Inc. (NYSE:HD) is a cyclical stock due to its close ties to the real estate industry. The firm’s sales are dependent on activity in the building and construction sector, which typically performs well when interest rates and inflation are low. Consequently, it’s unsurprising that The Home Depot, Inc. (NYSE:HD)’s shares are down by nearly 2% year to date, with the sell off accelerating in April after the inflation data dented Wall Street’s hopes for interest rate cuts. The Home Depot, Inc. (NYSE:HD)’s latest financial report released in May was a clear example of macroeconomics playing a greater role in its woes than business specific factors as its comparable store sales fell by 2.8% during the quarter. This marked the sixth consecutive drop and it also overshot analyst estimates of 2.09% by a wide margin. To sum it up, while The Home Depot, Inc. (NYSE:HD) ‘s $3.7 billion in cash provides it the heft to weather out macroeconomic storms, unless the economic outlook brightens, expect little fireworks from the firm.
The Home Depot, Inc. (NYSE:HD)’s management also commented on the macroeconomic environment during its latest earnings call. According to them:
Clearly, we’ve seen two years of significant decrease in housing turnover to the point where we’re at really sort of at historical lows. And most folks think that, that can’t get much lower. When you’re thinking about current performance, obviously, that puts pressure on our business. When a customer buys or sells a home, they spend more in that year than in a year when they don’t. And so there’s no doubt that we’re missing some of that project demand, and that’s what’s going on our sales as we had anticipated. Then you have to ask yourself though, the lock-in effect, the interest rate environment, at this point, a lot of subject to the macro.
I think the question is at what point current interest rates become sort of the new normal. This is not something that we’re making a prediction on. It’s just thinking about behavior. At some point, spend on housing shifts from discretionary to something that you simply must do. We know that there’s pent-up demand for household formation. And so again, I’d say short-term, it is having an impact on our customers’ mindset. And it’s not just housing turnover related spend. It’s really all large projects. As Billy said, sort of debt finance spend where we are seeing interest rates sort of weigh on the mind of customers. And look, we’re not immune to this. If you look at the national figures on what’s really driving the consumer right now, its services.
Goods are underperforming services and durable goods are seeing the most pressure and in particular, home-related categories. So this is not a surprise and this is baked into our expectations for the year. The question will be how it evolves over time.
9. NIKE, Inc. (NYSE:NKE)
Number of Hedge Fund Investors In Q1 2024: 71
NIKE, Inc. (NYSE:NKE) is a classic consumer cyclical stock as it sells high end athletic apparel and associated products. The firm has struggled in nearly all of its markets except for North America as a global economic slowdown and high inflation take a bit out of consumer budgets. To assuage investor concerns, NIKE, Inc. (NYSE:NKE) has sought to beef up its margins and earn more cents on the dollar. However, while the firm’s trailing twelve month gross margin sits at a respectable 44.2% (nearly a percentage point gain from FY 2023’s 43.3%), the latest earnings call saw NIKE, Inc. (NYSE:NKE) guide full year gross margin growth to 1.2 percentage points, which was below the midpoint of 1.5 percentage points that analysts were expecting. Consequently, NIKE, Inc. (NYSE:NKE) should struggle on the financial front until the global economic outlook improves. However, its position as one of the world’s leading sports apparel retailers can benefit from the Paris Olympic Games set to take place in July.
NKE shares lost nearly 30% year-to-date and currently have a forward PE ratio of only 20. Investors are concerned about the 2% year-over-year decline in NKE’s revenue despite the fact that NKE’s diluted EPS increased by 50% to $0.99 per share. This tells us that Nike increased its prices too much and it will probably have to offer large discounts to lure budget-conscious consumers back into its stores. NKE’s management expects around 5% revenue decline in fiscal 2025 which isn’t very encouraging given that RBC Capital forecasts €5.64 billion in group sales for Adidas in Q2 2024, representing an 8.5% organic growth. This suggests Nike may have brought on some of its own problems.
Polen Capital mentioned NIKE, Inc. (NYSE:NKE) in its Q1 2024 investor letter. While it was cognizant of the slowdown, the firm remained optimistic as it shared:
Nike has experienced a prolonged period of cost headwinds, offsetting its increasing revenue from direct-to-consumer channels, which would typically enhance its margins. In addition, a gap in new product innovations in recent years has caused earnings growth to stall temporarily. We see these transient headwinds abating, and the company plans to launch several innovations in footwear commensurate with the Paris 2024 Olympics. We believe this should lead to increased revenue growth as cost headwinds abate, thus accelerating earnings growth.
8. Tesla, Inc. (NASDAQ:TSLA)
Number of Hedge Fund Investors In Q1 2024: 74
Tesla, Inc. (NASDAQ:TSLA)’s primary business is manufacturing and selling electric cars. Along with this, it also sells energy storage equipment, provides semi autonomous driving software, and is focused on high growth industries such as robotics. Tesla, Inc. (NASDAQ:TSLA)’s reliance on EVs as its bread and butter means that the firm, like other consumer cyclical stocks, is at the mercy of economic trends. EVs are not cheap products, and easy consumer access to financing allows them to easily buy Tesla, Inc. (NASDAQ:TSLA)’s cars. The firm is also dependent on the global lithium supply chain and prices for its financial well being, and any supply disruptions that lead to rapid price increases end up hurting Tesla, Inc. (NASDAQ:TSLA)’s margins. It is also competing in the highly cutthroat Chinese market, where the threat of competition has forced it to reduce margins by lowering prices right when lithium prices are high, costs are rising, and access to financing is tough. However, Tesla, Inc. (NASDAQ:TSLA) enjoys considerable advantages over other EV companies because of its strong manufacturing model, and a major catalyst should be the highly anticipated cheaper EV that could spur demand.
Polen Capital mentioned Tesla, Inc. (NASDAQ:TSLA) in its Q1 2024 investor letter. Here is what the firm said:
Tesla’s narrative wasn’t just about being a great electric vehicle manufacturer. The way we see it, the narrative included Tesla becoming a fully autonomous fleet of electric vehicles (“Robotaxi”) soon, the charging platform for all E.V.s soon, an AI play, a global solar utility company soon, a future subscription business, a more. When we research Tesla, we see a differentiated auto business and the potential for many of these interesting “options” to be realized over a long enough period. However, the timing and true viability of many of these options are still unknown and often take much longer than many hope. To justify today’s valuation, even after the recent pullback, we see a company that needs to crack the mass market with a $25,000 or less model at acceptable margins. Yet, the company hasn’t articulated a clear path to getting there. Interest rates have risen, and competition in China has intensified, tempering demand for its existing, higher- priced cars. Valuation has become more difficult to justify at these levels. We feel the reality of these dynamics has finally started to settle into Tesla stock prices, and we look forward to seeing a more reasonable valuation that reflects the existing product portfolio and any future offerings that demonstrate a very clear path to near-term commercialization.
7. Lennar Corporation (NYSE:LEN)
Number of Hedge Fund Investors In Q1 2024: 75
Lennar Corporation (NYSE:LEN) is a major American home builder with a presence all over the country. Being a home builder means that the firm relies on low interest rates to fund its growth. This is true for the demand side and the supply side of Lennar Corporation (NYSE:LEN)’s business. The demand side relies on low rates to take out affordable mortgages, while the supply side relies on low rates to finance large building projects. Given that the market adjusted its rate cut expectations in April, it’s unsurprising that Lennar Corporation (NYSE:LEN)’s shares are down by 6.7% since then. However, the settlement of a historic home brokerage commission lawsuit earlier this year could see commissions drop and inject more demand into Lennar Corporation (NYSE:LEN)’s market. Additionally, in today’s high rate environment, the firm has proven to be quite agile. It is transitioning to an ‘asset light’ model through which it expects to reduce land holdings and reduce exposure to land speculation and high carrying costs.
Baron Funds was gushing about Lennar Corporation (NYSE:LEN)’s asset light model in its Q1 2024 investor letter. Here is what the firm said:
We are bullish on the long-term prospects for Lennar. We believe the company is exceptionally well run, favorably positioned to generate compelling long-term growth, and committed to unlocking shareholder value through several strategic initiatives.
Given its massive size (the company delivered 80,000 homes across its national footprint in 2023), Lennar benefits from important scale advantages that enable the company to attract labor, procure materials, and acquire land more easily and at more favorable pricing than its smaller competitors. Lennar is using these advantages to transition its business model into a “capital-light manufacturing operating model” whereby new homes are “manufactured” at a consistent pace throughout the year while employing a “land-light” strategy to reduce capital requirements. This transition is enabling Lennar to more easily meet its growth objectives (grow new home deliveries by approximately 10% per year) while improving operating and capital efficiency and reducing business risk. The transition has also led to improved cash-flow generation, which the company has been deploying for debt repayment, dividends and share purchases. The company is now sitting on approximately $5 billion of cash, which equates to approximately 11% of Lennar’s market capitalization. We anticipate that a large portion of this cash will be returned to shareholders via share repurchases. We are excited about this business transition and think it may lead to a higher valuation multiple over time.
We are also encouraged that management is exploring taking additional steps to create shareholder value by reducing capital intensity and simplifying the company. For example, last month management discussed the prospect of spinning off as much as $4 billion of land assets into a separate entity. Management may also monetize its partial interest in a large multi-family portfolio via the sale of the portfolio.
Although we are pleased with the strong recent share price performance of Lennar, we still underwrite compelling annual returns over the next few years, as we expect Lennar to compound book value per share at a mid-teens rate and see potential for the valuation multiple to expand further.
6. PDD Holdings Inc. (NASDAQ:PDD)
Number of Hedge Fund Investors In Q1 2024: 76
PDD Holdings Inc. (NASDAQ:PDD) is an online retailer that is known for its Pinduoduo platform in China and the Temu platform globally. While retailers are highly sensitive to economic cycles, PDD Holdings Inc. (NASDAQ:PDD) is one of the most unique firms in its industry. This is evident in its analyst share price targets. The average of 37 one year analyst share price targets for PDD Holdings Inc. (NASDAQ:PDD) is $202.67, which marks a hefty 44.7% upside over the recent closing price of $140. The shares are rated Strong Buy on average. This makes one wonder, why is PDD Holdings Inc. (NASDAQ:PDD) garnering such optimism even though China’s economy is slowing. Well, Pinduoduo’s market share grew to 19% in mid 2023 from 7.2% in 2019 as it leveraged the country’s economic weakness to its advantage. Pinduoduo allows users to bargain in groups, and as it eliminates middlemen from the retailer equation, customers are able to buy products at discounted prices. This provides PDD Holdings Inc. (NASDAQ:PDD) with a considerable advantage and could play in its favor globally as well as it leverages ties with Chinese merchants to ship low cost products overseas. However, trade tensions between the West and China remain a lingering threat and could affect the firm’s plans to expand to international markets if tariffs are placed on Chinese products.
Baron Funds mentioned PDD Holdings Inc. (NASDAQ:PDD) in its Q1 2024 investor letter. Here is what the firm said:
We added to our digitization theme by building a position in PDD Holdings Inc., a leading Chinese e-commerce platform. Founded in 2015, the company has emerged as China’s second largest e-commerce player, capturing approximately 20% market share. In our view, PDD’s competitive moat lies in its team purchase model that facilitates bulk buying through direct partnerships with manufacturers, thereby eliminating intermediaries (e.g., distributors and middlemen) and lowering costs. Key factors driving the company’s meteoric growth include rising consumer demand for affordable products in China amid an economic slowdown, small-scale merchants seeking alternatives to Alibaba, and superior management execution. PDD’s revenue growth outpaces gross merchandize value growth owing to rising take rates as merchants aggressively compete for consumer traffic on the platform. In our view, PDD should continue to gain market share given its dominance in the value-for-money segment, growing affordable branded product offerings, and high operational efficiency. We believe the company’s growth will be further supported by the recent launch of its international e-commerce platform, Temu, which has become one of the fastest growing apps globally. Leveraging China’s excess manufacturing capacity, Temu has strong negotiating power with domestic suppliers and attracts global consumers with competitively priced products. Temu’s recent initiatives to improve unit economics, coupled with achieving variable breakeven in the sizable U.S. market, showcase management’s skill and commitment to sustained growth. We expect PDD to at least double its earnings and free cash flow in the next three years, with the potential for continued compounding thereafter.
5. General Motors Company (NYSE:GM)
Number of Hedge Fund Investors In Q1 2024: 78
General Motors Company (NYSE:GM) is one of the largest traditional automakers in the US. This means that the firm has had to keep up with the times, since the rise of Tesla to the forefront of the industry has permanently altered its dynamics. General Motors Company (NYSE:GM) can no longer rely on its sizeable market share and brand image in a world where customers make the shift to electric vehicles and assisted driving technologies remove some of the fatigue involved with daily driving. However, General Motors Company (NYSE:GM) is still a sizeable company and its $26.6 billion in cash means that the firm has plenty of room to pursue high growth initiatives. This was evidenced by General Motors Company (NYSE:GM)’s decision in June to pump another $850 million in its Cruise self driving business, which remains beset with crashes that have rattled industry watchers. While it is also struggling in the EV industry and now plans to produce a high end of 250,000 EVs in 2024 (down from an earlier 300,000), General Motors Company (NYSE:GM)’s solid balance sheet allows it to accelerate share buybacks and keep investors happy as it finds its footing in the car industry of the modern era. Not to mention, its sizeable presence in the internal combustion car industry provides General Motors Company (NYSE:GM) with room to keep finances steady even if the EV sector is struggling.
Diamond Hill Capital mentioned General Motors Company (NYSE:GM) in its Q1 2024 investor letter. Here is what the firm said:
Automobile manufacturer General Motors continues capitalizing on the shift to electric vehicles (EVs) while maintaining the strength of its core gas-engine truck and SUV business. Though it has experienced some setbacks — such as needing to roll back its Cruise driverless car project — we believe the company remains well- positioned relative to secular tailwinds within the automobile business.
4. MercadoLibre, Inc. (NASDAQ:MELI)
Number of Hedge Fund Investors In Q1 2024: 79
MercadoLibre, Inc. (NASDAQ:MELI) is a Uruguay based eCommerce company. The firm’s business is the dream of every eCommerce company since it has managed to achieve the single biggest metric that firms in its industry target. This metric is fast delivery to areas uncovered by rival services. MercadoLibre, Inc. (NASDAQ:MELI) claims to deliver 80% of its packages within two working days, through a proprietary logistics network that leverages first mile collection to pick up the packages, receiving and consolidation centers to sort them and use other nodes to ship them to the right address. This enabled MercadoLibre, Inc. (NASDAQ:MELI) to deliver a whopping 71% growth in net income during its first quarter for a profit of $344 million. The firm enjoys a strong competitive moat because of its logistics network, and it is also diversifying its business to include digital payments.
On this front, here’s what Harding Loevner had to say about MercadoLibre, Inc. (NASDAQ:MELI) in its Q1 2024 investor letter:
MercadoLibre started its payments business, Mercado Pago, in 2003, only four years after launching its namesake e-commerce platform. It has since become the leading private payment provider in the region, accounting for 13% of all retail sales in Latin America, both online and offline, more than any single card issuer or private form of payment other than cash. Nearly three quarters of its payments now take place outside of MercadoLibre’s online site. Mercado Pago comprises more than half of the company’s total earnings and cash flow, which has helped to fund investments elsewhere—especially in logistics—that have served to reinforce its lead in e-commerce.
Mercado Pago has been especially important to MercadoLibre’s success in Mexico, the region’s second-largest economy and MercadoLibre’s third-largest market, accounting for more than 20% of its sales. With the largest unbanked population in Latin America, many online shoppers have had to pay cash on delivery, a sometimes cumbersome process that Mercado Pago was able to help resolve. For more than half of MercadoLibre’s users, Mercado Pago was the first digital payment method available to them. In addition, more than half of the credit offered by Mercado Pago went to customers getting their first access to credit ever; half of them were women, who have been particularly underserved by banks
. . . .MercadoLibre and FEMSA have built valuable businesses for themselves in payments, ones that also address a pressing need for many customers of their retail businesses. There is still much work to do in promoting financial inclusion in Latin America compared to many other emerging markets (see chart above). That also means there is a continuing opportunity for MercadoLibre, FEMSA, and other companies to lower financial barriers for customers while at the same time differentiating themselves from their competitors and boosting their own businesses.
3. Booking Holdings Inc. (NASDAQ:BKNG)
Number of Hedge Fund Investors In Q1 2024: 97
Booking Holdings Inc. (NASDAQ:BKNG) is a digital travel services provider. The firm is a key player in the emerging online travel services industry which allows businesses to leverage the power of the Internet to serve a global customer base. Booking Holdings Inc. (NASDAQ:BKNG) benefits from its strong user base, with more than 100 million users of its software application in 2023. This provides it with a sizeable platform that the firm has to maintain and satisfy in order to keep revenue growing. In the age of AI, the user data (Booking Holdings Inc. (NASDAQ:BKNG) had 563 million site visits in May 2023 according to Semrush) also enables the firm to use AI specific to the needs of the travel industry to cater to customer needs. Booking Holdings Inc. (NASDAQ:BKNG)’s AI initiatives include Trip Planner and Penny, which provide customers with responses that leverage its data to suit their travel needs. Yet, like other travel companies, Booking Holdings Inc. (NASDAQ:BKNG)’s performance is contingent on the health of the global travel industry, which itself depends on global economic and inflationary trends.
Booking Holdings Inc. (NASDAQ:BKNG)’s management commented on its AI initiatives during the Q1 2024 earnings call. Here’s what they said:
In addition, we have proprietary data that can be used to train specific use case models or fine tune large AI models and have the resources and scale required to help build AI powered offerings. As we have discussed before, our teams continue to work hard to integrate generative AI into our offerings in innovative ways, including booking.com’s AI trip planner, price wise generative AI travel assistant named Penny and Kayak’s recent release of generative AI powered features and tools. We will continue to learn from traveler interactions with these tools and enhance our offerings over time. In addition, customer service, which is a critical function that we provide to both our travelers and partners, is an area we believe will be meaningfully enhanced by AI advancements.
At each of our OTA brands, our teams are actively exploring ways to leverage generative AI technology to improve self-service tools which we believe will reduce live agent contact rates and enable us to answer traveler questions faster. When customers still need to speak with a live agent, we believe that this technology will improve our live agent’s efficiency by making it easier to access information and document the conversations. In sum, we believe Gen AI will lower our customer service costs per transaction over time and improve the customer experience.
2. Alibaba Group Holding Limited (NYSE:BABA)
Number of Hedge Fund Investors In Q1 2024: 103
Alibaba Group Holding Limited (NYSE:BABA) is a diversified Chinese company that primarily operates in the eCommerce industry. Data from the Hong Kong based DBS bank shows that Alibaba Group Holding Limited (NYSE:BABA) had a market share of 40% based on gross merchandise volume. This makes it a dominant player in the industry and provides it with stability in a weak Chinese economy. The sizeable user base, coupled with a cut throat Chinese market full of emerging eCommerce players like Pinduoduo, means that Alibaba Group Holding Limited (NYSE:BABA) needs to be on its toes if it’s to keep its dominant position. Alibaba Group Holding Limited (NYSE:BABA) has launched its AI based Alimama tool that enables merchants on its platform to advertise their products based on return on investment (ROI). Like its American peer Amazon, Alibaba Group Holding Limited (NYSE:BABA) also has a sizeable presence in the Chinese cloud computing market (37% share according to DBS). This provides it with a diversified revenue base in a highly lucrative market – particularly so when AI is brought into the product mix.
Alibaba is expected to generate around $20 billion in earnings over the next 12 months. Its current market cap is $175 billion but it has $50 billion in net cash according to Yahoo Finance. This means the stock is trading at an adjusted PE ratio of 6. This is because investors don’t trust the Chinese government. We haven’t even considered adjusting our valuation metrics for Alibaba’s large stakes in other companies and the future potential of its AI and cloud investments. If BABA were a US-based company operating in the US, it would have been trading at around $400.
Artisan Partners mentioned Alibaba Group Holding Limited (NYSE:BABA) in its Q1 2024 investor letter. Here is what the firm said:
Alibaba shares declined 7% during the quarter. There isn’t much new to say about Alibaba. There was no meaningful news that drove the share price decline. The earnings for the December quarter were fine, with revenues and profits both increasing 5%—not typically an exciting level of growth, but certainly enough to justify the company’s paltry valuation of 4X–5X EBIT. As we have written in recent letters, this is a valuation level that is normally reserved for a dying business, and Alibaba is not a dying business. Management continues to implement changes that are intended to increase shareholder value. Over the past year, they have changed management, adjusted the company structure, contemplated spinning off assets, made progress monetizing the balance sheet and have improved the capital allocation. All of these actions have yet to be reflected at all in the share price. This is a stock that could double and would still be cheap.
1. Amazon.com, Inc. (NASDAQ:AMZN)
Number of Hedge Fund Investors In Q1 2024: 302
Amazon.com, Inc. (NASDAQ:AMZN) is the world’s largest eCommerce provider, which allows it to command a substantial market. Its market size means the firm has to keep its focus on maintaining efficiency metrics to ensure that it does not lose market share to emerging competitors. Some of the metrics that Amazon.com, Inc. (NASDAQ:AMZN) needs to keep its eye on are increasing the number of day deliveries, reducing costs, optimizing its fulfillment network, and improving engagement with sellers to provide them with added value. Additionally, Amazon.com, Inc. (NASDAQ:AMZN) is also one of the biggest cloud computing providers in America. With considerable resources at its disposal, the firm has a robust semiconductor design division, and its partnership with AI firm Anthropic provides it with runway to make more moves in the AI sphere – particularly when it comes to developing AI chips to reduce dependence on NVIDIA’s products. Finally, Amazon.com, Inc. (NASDAQ:AMZN) also relies on its vast user base to run advertisements for its customers, and like the rest of its business divisions (eCommerce and Cloud) this segment is also vulnerable to any economic slowdown that affects business spending.
Since cost control is one of the lesser talked about aspects of Amazon.com, Inc. (NASDAQ:AMZN)’s business success, here’s what Alphyn Capital had to say in its Q1 2024 investor letter:
My previous analysis (Q4 2022 letter) highlighted the significant growth in Amazon’s fulfillment expenses since 2015, masking the true earnings potential of its retail business. Though initially costly, the recent restructuring into regional fulfillment centers has yielded lower fulfillment costs and faster shipping times, leading to increased purchase frequency, especially among Prime members.
Following the regionalization effort, over the last couple of years, Amazon prioritized cost control and reduced capital expenditures. At a high level, the North American segment’s operating income swung from a $240 million loss in 2022 to a healthy $6.4 billion profit (6% margin) in 2023. Combined with continued strength in AWS and advertising, Amazon’s free cash flow (as reported, excluding equipment finance leases and principal repayments) surged from negative $13 billion to positive $36 billion.
Amazon stands out for pioneering the public market strategy of prioritizing long-term growth through sustained low margins and reinvestment, with the ability to later “turn on the taps” for profit. While many public tech companies have tried to replicate this approach, Amazon’s scale and execution capabilities make it one of the few that have successfully pulled it off.
Even though AMZN is naturally the favorite hedge fund consumer cyclical stock pick, our conviction lies in the belief that some AI stocks hold greater promise for delivering higher returns and doing so within a shorter timeframe. If you are looking for an AI stock that is more promising than AMZN but that trades at less than 5 times its earnings, check out our report about the cheapest AI stock.
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Disclosure: None.
