Both Hedge Funds and Mutual Funds Are Buying These Fantastic Fintech Stocks, and That's a Great Signal for Investors to Buy

Investment managers seemed to favor one particular equity market sector last quarter as artificial intelligence (AI) stocks wavered. Hedge funds increased their tilt toward financial stocks by 300 basis points, according to an analysis by Goldman Sachs' Ben Snider. He also noted that mutual funds increased their exposure to levels last reached in 2012 relative to their benchmark indexes.

Two fintech stocks have found favor with both hedge funds and mutual funds, which tend to have different investment time horizons. That means both near-term catalysts and long-term trends could push the stocks higher from here, even though they've already seen their prices climb considerably since the end of March.

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The two fintech stocks smart money is buying

Snider identified Visa (NYSE: V) and Mastercard (NYSE: MA) as "shared favorites" among hedge fund and mutual fund managers. That means a large number of hedge funds hold the stocks and mutual funds, as a group, are overweight in the stocks. It's a list Goldman Sachs has maintained since 2013, and the group has historically produced an annual return of 17%, about two percentage points more than the S&P 500 average during that period.

Of course, investors should always heed the usual caveat: Past performance is not an indication of future results. But Visa and Mastercard are wonderful businesses that benefit from a significant competitive advantage and can generate earning growth at a sustainably high rate for a long time. Hedge funds and mutual fund managers who bought the stocks last quarter certainly got a fantastic price for the stocks. Despite both trading at a premium today, they're worth paying up for right now.

Billionaire Bill Ackman described the pair as "capital-light 'toll-takers' that earn a nominal fee on each transaction without taking any material risk and are natural beneficiaries of higher inflation." On top of that, digital payments are growing faster than consumer spending, as card payments still account for just half of all spending globally. Considering the global reach of the payments networks, there's a long runway for continued market penetration and growth. Ackman was among the fund managers who established positions in Visa and Mastercard last quarter.

To Ackman's point, payment volume at both Visa and Mastercard rose 10% year over year last quarter. But beyond increasing payment volumes, the card networks also offer value-added solutions for banks, merchants, and other fintechs that use their networks. Services such as fraud prevention, data and analytics, rewards programs, and cybersecurity are rapidly growing and adding to both companies' bottom lines. Visa's value-added services revenue climbed 34% last quarter. Mastercard's value-added services gained 20%.

The long-term potential

Visa and Mastercard dominate the payments network industry as the clear No. 1 and No. 2 providers, respectively. Their positions are cemented by network effects, which makes their products increasingly attractive as more and more people use them. Although margin expansion has stalled in recent years, that could improve as value-added services boost revenue growth at both companies. As a result, both could produce earnings that increase faster than revenue growth for the next few years.

Both can reliably deliver double-digit percentage revenue growth in the long run, driven by rising consumer spending, increased share of spending with credit and debit cards, and improved penetration of value-added services. That's led Ackman to project earnings-per-share (EPS) growth for both companies of between 16% and 18% during the next three to five years. Wall Street analysts on average currently estimate 13.5% annualized EPS growth for Visa during the next two years, and 16% for Mastercard.

Importantly, though, both companies are positioned for earnings growth at a sustainable double-digit percentage level for the foreseeable future. That's why, even with stocks trading at 25 to 30 times earnings expectations, they can still be great investments today.

Adam Levy has positions in Mastercard and Visa. The Motley Fool has positions in and recommends Goldman Sachs Group, Mastercard, and Visa. The Motley Fool has a disclosure policy.