After a positive start in January, S&P 500 Has been sold since the beginning of February and is now down 12.5% over the last year. Given the broad market index decline, it makes sense to start buying some stocks with excellent long-term growth prospects. data center equipment company vertive (VRT 3.70%) and owner of Google Alphabet (GOOG 2.65%) (GOOGL 2.81%) are two great stocks to consider.
Vertive looks good on a risk/reward basis
Based on management’s full-year 2023 guidance, Vertive stock is a great value. For example, management is expecting organic revenue growth of 14% to 17%, adjusted free cash flow (FCF) of $300 million to $400 million, and earnings per share (EPS) of $1.17 to $1.27 . The midpoint of guidance puts Vertiv at a forward price-to-FCF multiple of approximately 14 times FCF and a forward price-to-earnings multiple of less than 11 times earnings.
Furthermore, Vertiv’s stock looks like a no-brainer given long-term demand growth in the core end markets for Vertiv’s data centers and digital infrastructure equipment.
That said, there’s a reason Vertiv’s stock trades so cheap. It probably comes down to the fact that it missed FCF guidance in the fourth quarter. Management had forecast a year-over-year improvement of $242 million to $292 million for Q4, for the figure coming in at just $135 million of improvement. The fear is that Vertiv could see some delayed collections and advanced payments for orders that could be canceled in 2023.
Investors will be keeping a close watch on the management’s first quarter FCF and working capital numbers. Guidance is for adjusted outflows of $75 million and working capital improvements of $15 million. If management hits these numbers and maintains full-year guidance, I think the stock has the potential to move higher materially.
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There are two reasons to feel positive. First, its peers continue to talk of a strong end market for data center spending in 2023. Second, some major data center companies continue to see increasing occupancy and utilization rates.
For example, equinoxThe utilization rate in the US was 80% in the fourth quarter, compared to 76% in the same quarter a year ago. Its Asia usage ranged from 79% to 83%, and Europe, the Middle East and Africa were flat at 83%. Similarly, Digital Realty TrustThe occupancy rate in Q4 was 84.7%, compared to 83.6% in the same quarter of 2021, and its management expects to end 2023 at 85% to 86%. Rising occupancy rates indicate the need for more investment to build capacity, and that’s good news for Vertiv.
alphabet, here comes the cash flow
Vertiv sells into the colocation data center market (which includes companies like Equinix and Digital Realty). It also sells into growth markets such as the cloud/hyper-scale market, which includes companies Microsoft’s Blue, Amazon Web Services, and Google Cloud.
In fact, Google Cloud’s growth (revenue up 32% year over year in Q4 to $7.3 billion) is a major reason to buy Alphabet stock. While the business is still loss-making, its recurring revenue and cash flow model means that it will certainly add a significant amount of cash flow to the business in the years to come.
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Meanwhile, Google’s core search business remains a prodigious cash generator. Much has been made of a 2% decline in Google search and other advertising revenue to $42.6 billion in Q4 2022. Currency moves, according to CFO Ruth Porat. It’s also worth noting that slowing consumer spending typically leads advertisers to pull back on spending — a situation that’s likely to reverse when interest rates stop rising.
Wall Street analysts project Alphabet’s FCF to grow from $60 billion in 2022 to $70.6 billion in 2023 and reach $100 billion in 2025. Given that Alphabet is also poised to have $122.5 billion in net cash at the end of 2023, this is a company that will generate and retain significant amounts of cash for years to come. That cash could be put to good use as a growth-enhancing investment and support Google Cloud’s march to profitability, so there’s plenty of upside for the stock.
Susan Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. John Mackey, former CEO of Whole Foods Market, is a member of the board of directors of The Motley Fool, a subsidiary of Amazon. Lee Samaha has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Alphabet, Amazon.com, Digital Realty Trust, Equinix and Microsoft. The Motley Fool has a disclosure policy.
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