Billionaire David Tepper Has 40% of His Fund in Just 3 AI Stocks. Are They Still Buys?

Billionaire hedge fund manager David Tepper of Appaloosa Management is considered one of the world's top investors, and he's not afraid to make big bets. In fact, at the end of the second quarter, 40% of his portfolio was in just three artificial intelligence (AI) stocks: Amazon (NASDAQ: AMZN), Micron (NASDAQ: MU), and Taiwan Semiconductor Manufacturing (NYSE: TSM). Let's look at why all three still look like buys right now.

Amazon

Amazon is Tepper's largest holding, representing more than 15% of his portfolio, and he added to his shares in Q2. It's easy to see why he would like the stock.

Amazon is the market leader in both e-commerce and cloud computing. Amazon Web Services (AWS) is its largest business by profitability and its fastest-growing. AWS growth has been accelerating, and Amazon is investing heavily in AI infrastructure to sustain the momentum. It gets a quick two- to three-year payback on its chip and networking investments, while locking in deals for five or more years. Its economics should improve even more as it starts to use more of its own chips. With a $496 billion backlog and the company projecting that AWS could become a $1 trillion revenue business, Amazon has a long runway of growth ahead in the cloud computing space.

At the same time, its e-commerce business is also poised to perform well, with its investments in AI and robots leading to strong operating leverage. Its high-margin sponsored ad business is also growing quickly, and it's become one of the largest digital advertising platforms in the world.

Micron

Micron is Tepper's second-largest position, accounting for over 14% of his holdings. While he was trimming his stake in Q2, a pullback in the stock from its Q2 highs makes it attractive.

Micron has been riding the memory supercycle, which has led to surging revenue growth and huge gross margin expansion. The memory market is being driven by soaring demand for high-bandwidth memory (HBM), which gets packaged with graphics processing units (GPUs) and other AI accelerators to improve performance. HBM supply is tight, and demand is through the roof, and this likely will remain the case for several years.

The big three DRAM (dynamic random access memory) makers, which also include Micron's Korean competitors, SK Hynix and Samsung, have put most of their focus into increasing HBM supply. However, this has led to ordinary DRAM and NAND (flash) prices surging even higher than HBM prices, which is benefiting Micron, as a smaller percentage of its revenue comes from HBM. Meanwhile, HBM and advanced logic chips competing over a scarce amount of EUV (extreme ultraviolet lithography) machine supply and HBM requiring a lot more wafer capacity than regular DRAM are likely to keep the DRAM market imbalanced for years into the future.

With a forward price-to-earnings (P/E) ratio of below 6.5 times and the memory market supercycle looking like it will last much longer than any past cycle, the stock looks attractive right now.

Hedge fund manager David Tepper: Image source: Getty Images.

Taiwan Semiconductor Manufacturing

Rounding out Tepper's three-largest holdings is Taiwan Semiconductor Manufacturing (TSMC), representing over 10% of his portfolio. The billionaire hedge fund manager, meanwhile, aggressively increased his position in the stock by about 24% in Q2.

In my view, TSMC is one of the best stocks to play the AI infrastructure build-out. Through its technological expertise and scale, the company has become a near-monopoly in advanced chip manufacturing, as it is the only foundry that has reliably demonstrated it can produce the most advanced chips at high yields (few defects). This, in turn, has led to strong pricing power and the company becoming inextricably tied to its customers' chip roadmaps.

The great thing about TSMC is that it is benefiting from the surge in all types of chips, whether GPUs, custom AI ASICs (application-specific integrated circuits), or advanced central processing units (CPUs). With the stock down since the end of June, it looks like a buy in my book.

Geoffrey Seiler has positions in Amazon. The Motley Fool has positions in and recommends Amazon, Micron Technology, and Taiwan Semiconductor Manufacturing. The Motley Fool has a disclosure policy.