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It has been a difficult year for stocks generally, and especially growth stocks. As inflation spiked and interest rates followed, the hit to growth stocks, with the bulk of their profits well out in the future, has been especially large.
However, not all growth stocks are unprofitable, and some market leaders are likely to be quite resistant to a recession. The following three stocks have some nice defensive qualities that should hold up even in an adverse economic environment and should also thrive over the longer term.
Even if a company is the second-largest in the world by market cap, that doesn’t mean it’s done growing. After all, Microsoft (MSFT -1.73%) has been able to consistently grow by double digits in most quarters over the past decade, especially under CEO Satya Nadella, who took the helm in 2014.
MSFT Revenue (Quarterly YoY Growth) data by YCharts.
The past quarter saw Microsoft’s revenue growth decelerate to “only” 10.9%, but that had to do with huge currency movements this year, decreasing revenues in its large international business in dollar terms. In constant-currency terms, Microsoft’s growth was actually 16%.
Even better, Microsoft looks like it will be able to maintain good growth for years. After all, Microsoft has a number of exciting business segments growing at much higher rates. These include the Azure cloud platform, which grew 42% in constant currency; Microsoft’s ERP software suite Dynamics 365, up 22%; and even non-cloud software segments like LinkedIn and Bing search, which were each up 21%. As these businesses make up a larger part of the enterprise going forward, that should help put a floor under Microsoft’s growth.
Microsoft’s holistic offerings, in which it can offer bundled cloud infrastructure and data analytics software, are resonating with customers. Just this week, Microsoft announced a high-profile 10-year cloud deal with the London Stock Exchange Group (LSE -2.81%). Interestingly, Microsoft wound up taking a strategic stake in LSEG as part of the deal.
Double-digit growth combined with sky-high operating margins north of 40% is the mark of a truly great business. Twenty-five times this year’s earnings estimates (for the fiscal year ending June 30) doesn’t seem such a high price to pay for that kind of strength, making Microsoft a stock investors can comfortably buy in this uncertain environment.
Next-generation applications such as artificial intelligence, industrial automation, 5G communications, and others depend on advanced semiconductors. Leading-edge semiconductor production depends on Extreme Ultraviolent Lithography (EUV), and there’s only one company with a monopoly on this technology: ASML Holdings (ASML -0.99%).
ASML initially sold off hard this year, along with the semiconductor sector, which has historically been quite cyclical. Yet while semiconductors are going through a broad decline in demand, the investment in future chip production doesn’t seem to be quite as volatile.
This is because chip fabrication plants take a long time to build. At its recent Investor Day, ASML’s CEO Peter Wennink made the point that ASML’s backlog is likely longer than any upcoming recession would be! Thus, ASML’s growth should be smoother than more cyclical chips tocks.
In fact, ASML just raised its long-term 2025 targets relative to where they were last year and forecast strong continued growth through 2030. Chalk up the raised targets to greater demand for AI servers, the Metaverse, and an accelerated green energy transition. In addition, management claims “re-shoring” of semiconductor production in countries outside Taiwan is likely to increase semiconductor equipment investment by 10% relative to baseline demand.
While other types of equipment stocks may see a decline in 2023, that doesn’t seem to be the case with ASML, whose capacity is still beneath soaring demand. This is because EUV machines are essential to companies’ and countries’ long-term product roadmaps, competitiveness, and national security.
If the company hits its 2030 targets, the stock really only trades around 10 times that earnings figure. Meanwhile, ASML has routinely beaten its prior forecasts historically. And as a highly profitable stock, ASML has the capacity to continue repurchasing shares and raise its 1% dividend annually over that time period.
The telecom industry isn’t exactly known for its eye-popping growth, but T-Mobile (TMUS -0.52%) should see a material acceleration in free cash flow next year. That’s because 2022 should mark the peak of T-Mobile’s integration spending following its 2020 Sprint acquisition.
That merger gave T-Mobile a lead in mid-band 5G, catapulting T-Mobile’s network ahead of rivals. That’s a contrast from the 4G era, in which T-Mobile was a network laggard.
Things seem to be coming together nicely for T-Mobile, which has beaten expectations and raised guidance in each of the three reported quarters in 2022. Last quarter, the mobile giant recorded industry-leading growth in postpaid net additions for accounts, customers, and phones. Services revenue grew 6.9%, core adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) grew an even higher 26.3%, and free cash flow was up an even higher 32.5%.
Free cash flow is inflecting higher at T-Mobile because the company is just finishing the bulk of its mid-band Ultra Capacity 5G buildout, which now covers 260 million Americans, as well as the decommissioning of extra Sprint radio towers. For context, its competitors don’t anticipate getting to those coverage numbers for two years.
With more people now acquiring 5G phones, look for T-Mobile to continue growing, even as its capital expenditures come down next year. That execution is why T-Mobile was confident enough to begin its new share repurchase program in September, a few months earlier than it had forecast at its March 2021 investor day.
In a tough year for tech stocks, T-Mobile has actually risen on the back of these strong results. Yet given its recession-resistant business, accelerating free cash flow, and buybacks, investors shouldn’t hesitate to pick up shares of this winning company for 2023 either.
Billy Duberstein has positions in ASML, Microsoft, and T-Mobile US and has the following options: short January 2023 $125 puts on T-Mobile US. His clients may own shares of the companies mentioned. The Motley Fool has positions in and recommends ASML and Microsoft. The Motley Fool recommends T-Mobile US. The Motley Fool has a disclosure policy.
*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.
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