We recently compiled a list of the 10 Best Aggressive Growth Stocks to Buy According to Hedge Funds. In this article, we are going to take a look at where Nu Holdings Ltd. (NYSE:NU) stands against the other aggressive growth stocks.
If you’re putting money in the stock market, it’s more likely than not that growth is the thing that’s on your mind. After all, protecting against inflation doesn’t require making risky bets in firms that might see share prices drop in the blink of an eye. Financial instruments, such as inflation protected securities, offer investors the comfort of knowing that their savings do not lose value, meaning that passive income or growth remain some of the most popular reasons why people put their faith in stocks.
When it comes to identifying growth stocks, there are several approaches that are followed. These depend on the business model and the fundamentals of the firms being analyzed. For instance, for profitable companies with a positive net income, the price to earnings ratio is used. However, a large portion of high growth stocks aren’t profitable as they reinvest their revenue into expanding market share. This leads to high operating costs, and these firms are valued either through the EV/Sales or EV/EBITDA ratios, depending on whether the firm generates a positive operating income or not.
Both the P/E and other ratios tell us the premium that the market is placing over a firm’s ability to generate money. For instance, one of the major semiconductor companies in the world, which ranks 6th on our list of Top 10 Trending AI Stocks on Latest Analyst Ratings and News, had a P/E ratio of 112x by the end of Q1 2018. This was before the age of AI, and its two peers in the chip industry had 37x for the chip stock that’s Wall Street’s AI darling and 19x for the struggling American chip giant that’s also the only leading edge US based chip manufacturer. Safe to say, the 112x P/E foretold the story of times to come, and since Q1 2018, the stock has gained a whopping 1,386%.
Of course, this stock’s story isn’t the only aggressive growth stock story that we have. While its revenue has grown by 254% between 2018 and 2023, one of the best stories of an aggressive growth stock of our age is Elon Musk’s electric vehicle company. The firm had a stunning P/E ratio of 1,120x by the close of 2020 at a time when the retail investing frenzy was at a feverish pitch. Its first profitable quarter, i.e. the quarter ending in June 2020 saw its P/E jump to 512x at a time when its larger and traditional rival was trading at 23.89x. Since then, the shares have gained 180%, and their gains have been trimmed due to the turmoil in the EV industry stemming from supply chain constraints, margin eroding fierce competition, and high interest rates. The stock’s all time returns sit at 17,569%.
Shifting gears, the electric vehicle company had an EV/Revenue ratio of 23.56x in August 2012. Similar ratios are typically common in the cloud computing and software as a service (SaaS) industry. As opposed to car manufacturers that face high manufacturing and indirect costs, cloud and SaaS firms reap the benefits of a low cost business model as it takes less money to develop software than to operate an industrial plant. This also means that the firms have more cash at their disposal to focus on growth, and the low margins coupled with the high reinvestment have a direct implication on their valuation.
Looking at the SaaS sector’s median EV/Revenue multiples, data shows that they are affected by interest rates. Higher interest rates increase the opportunity cost of investing in the stock market, and they also decrease the value of future SaaS earnings in today’s dollars as investors can earn more money today through interest. This is also evident in the data, as before the pandemic, the median EV/Revenue multiple was 11x. After the pandemic, when the Federal Reserve was forced to lower rates to nearly zero to avoid economic destruction, the SaaS median EV/Revenue multiple shot to 20x in 2021 as investors found little utility in earning money through interest.
Now, when the rates are at historic highs, the median multiple over the past 18 months has hovered around 7x. The post pandemic economic disruption has also had an effect on SaaS growth, since pre pandemic, the median revenue growth rate for these firms was 30%, and in the low rate era as the demand for technology services boomed, it grew to 33%. However, the high rates after that, which slowed down business spending, have also impacted the revenue growth rate which is around 17% as of Q1.
Building on this, the SaaS and the broader software industry are also dealing with the impacts of AI. Among the use cases of the new technology is programming, with research from the hedge fund Coatue Management sharing some key insights. Its research shows that high rates might not be the only reason for the sector that’s historically been thought to have constituted the highest number of aggressive growth stocks. As per Coatue, compared to a peak value of 30%, the median next twelve month revenue growth rate for the SaaS sector right now is just 1%. This appears to be influenced by AI’s impact, as not only has AI reduced the cost of writing code (meaning that SaaS customers can use AI to make their own software) but it is also impacting the traditional seat based model of the industry. This model sees SaaS firms charge customers on the basis of the number of people or ‘seats’ that have access to their software, and the seat model is now being replaced by consumption driven models.
This transition is already playing out in the industry, with one software firm sharing during its Q2 2024 earnings call:
“Subscription revenue was $278.1 million, a 21% increase over last year. Now, with the transition that we went through to pay-as-you-go consumption pricing, we are engaging in a much larger number of smaller transactions of shorter term. This offers us greater revenue visibility and greater revenue predictability. Our average TCV [TOTAL CONTRACT VALUE] has plummeted as a result from over $16 million in fiscal year ’19 to $900,000 last quarter. As we work through this pricing transition, we are seeing, as expected, okay, at first a decline and now a return to accelerating revenue growth. Also as expected, we are seeing a reduction in RPO.”
So, as the aggressive growth stock sector appears to be evolving, we decided to see which such stock hedge funds are buying.
Our Methodology
To make our list of the best aggressive growth stocks to buy, we first ranked the 155 stock holdings of a popular ETF that selects stocks based on the belief that their earnings will grow faster than the average. Then, out of this list, those stocks with a 30%+ annual revenue growth rate during the latest quarter were chosen. These stocks were ranked by the number of hedge funds that had bought the shares during Q2 2024 and the top stocks were chosen.
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).
A wide angle shot of a team of bankers and financial advisors evaluating an investment portfolio on a touchscreen monitor.
Nu Holdings Ltd. (NYSE:NU)
Revenue Growth: 65%
Number of Hedge Fund Investors In Q2 2024: 59
Nu Holdings Ltd. (NYSE:NU) is a Brazilian bank with a presence in the US, Germany, and other countries. It is one of the most interesting banks in the world due to the fact that it operates through a digital banking model and its primary markets are the high growth, low penetration regions of Brazil, Mexico, Colombia, and others. These countries typically see customers struggle with banking due to large incumbents, and Nu Holdings Ltd. (NYSE:NU) also benefits from low operating costs because of its digital banking model. The lower costs enable the bank to compete effectively against Brazilian banking giants who struggle with high overhead costs. Another key advantage for the firm is its data driven business which allows Nu Holdings Ltd. (NYSE:NU) to identify customer trends and preferences and market additional products to grow revenue. These advantages mean that Nu Holdings Ltd. (NYSE:NU) can only further grow in the future provided that management does not move its eye from the prize.
Baron Funds mentioned Nu Holdings Ltd. (NYSE:NU) in its Q2 2024 investor letter. Here is what the firm said:
“Nu Holdings Ltd. is a digital bank with operations in Brazil, Mexico, and Colombia. Shares appreciated during the quarter after the company reported strong balance sheet growth and improving margins. New product launches and expansion in newer countries are yielding favorable results. Nu also benefited from inclusion in the MSCI Brazil Index, which prompted buying from passively managed funds. We continue to own the stock because Nu is disrupting the financial services industry in Latin America with its digital distribution and intense focus on user experience. The company has grown to serve over 90 million customers in less than 10 years, largely through word-of-mouth referrals. We believe the company’s superior product offering will drive continued share gains in large and growing markets.”
Overall NU ranks 6th on our list of the best aggressive growth stocks to buy according to hedge funds. While we acknowledge the potential of NU as an investment, 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 NU 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. This article is originally published at Insider Monkey.