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February 24th, 2023

Five Stocks for 2023

Slowing economic growth and sharply rising inflation are forcing a repricing of risk in the equity markets. This is further compounded by an expected decline in corporate earnings as companies navigate higher labor and raw material costs. Following the Fed pushing interest rates higher last year, we expect the dislocation in stock prices and the increase in volatility to carry over into 2023. Equity valuations are slightly elevated given the rally in prices so far this year. However, we believe there are good investment opportunities in stocks across sectors. Here are five stocks that Winthrop considers high-conviction investment ideas based on underlying fundamentals, current valuation, and expected forward earnings growth.

Amazon [AMZN]

Over the past ten years, Amazon has become a household name for consumers.  The company has invested heavily in building its distribution warehouses around the country in order to provide efficient home delivery for online orders. However, Amazon Web Services is the lesser-known affiliate despite being the leader in cloud infrastructure, with 35% of the total market share.  The growth in cloud, and high margins, has led to AWS being 74% of Amazon’s net income, despite being only 15% of total revenue.  The cloud space had a difficult year and contributed to Amazon’s stock price decline of 50% in 2022.  AWS is expected to generate $100 billion in revenue by the end of 2026. Because the cloud is valued at a higher multiple, the argument could be made that AWS alone is worth the current market cap of Amazon.  The stock is currently trading at 1.8x sales and EV/EBITDA multiple of 17x making it the cheapest the stock has ever traded.  The retail and grocery business will remain low growth, low margin foundational segments of the company but we see ad revenue as the next revenue growth driver for the company.  Amazon currently has 15% of the online ad revenue market.  Long-term adoption of Alexa within the integrated connected home will provide a catalyst to the current growth of 25% year over year.  Even through an economic slowdown, we believe earnings will grow to $2.68 per share with normalizing investment costs.

Tencent [TCEHY]

Tencent is the holding company for one of the largest portfolios of media and gaming companies around the globe.  Shares are down over -50% from their highs and are trading at 13x forward earnings.  Mobile gaming and fintech services are their largest growth drivers at 20%+ expected growth per year.  We expect growth in China’s economy will accelerate as the country moves out of its Covid lock downs, which should provide a catalyst for further accelerating revenue growth for TCEHY.  Despite the pervious economic and political issues in China, international gaming and video monetization is growing near 25%.  The Chinese government is quickly rolling back some of the regulatory pressures that have clouded the growth potential of Tencent.  With its robust cash flow projected for this year, we expect that excess cash flow will be directed to share repurchases.  Unlike many Chinese company ADRs, Tencent files full GAAP financial reports and is not under audit review by the SEC. 

Medtronic [MDT]

In 2022, the healthcare sector outperformed the broad market, falling just -3% while the S&P dropped -19%. During the pandemic, the healthcare industry shifted toward fighting Covid and lowered the priority for elective healthcare. However, as a subsector, medical devices lagged as elective and deferred surgeries did not rebound as quickly as expected following Covid. Many companies in this space experienced drastic selloffs with the medical device index falling over -20%. Today, this sector is trading at a discount with solid growth potential given pent up demand for elective procedures. In addition, the aging of the global population provides a catalyst for the medical device market to expand.

In the medical device space, we believe Medtronic offers relative stability with an attractive valuation. Medtronic operates in four segments including medical, neuroscience, diabetes, and cardiovascular. It is a diversified medical device company treating over 70 diseases and has a presence in over 150 countries. The company produces over $30 billion in annual revenue with nearly half of its revenue from developed and emerging markets. At an EV/EBITDA multiple of 13x, it is trading cheaper than its peers which include Becton Dickinson, Stryker, Zimmer Biomet, Boston Scientific, and Baxter International. Medtronic is currently trading at 15x forward earnings, well off its average P/E of 20x and cheaper than the industry peer average of 24x. The company is trading lower from its peak by nearly -30%. With the medical device industry expected to grow at a CAGR of 5.5% for the next 5 years, Medtronic will remain one of the biggest beneficiaries with its deep portfolio of cardiovascular, medical, and diabetes products. As one of the most diversified healthcare companies in the industry trading at similar valuations to its COVID lows, we believe the company will return to hit its 3-5% growth targets as its pipeline opens up and its segments normalize after temporary supply chain setbacks.

S&P Global [SPGI]

S&P Global operates under five business segments including Market Intelligence, Ratings, Mobility, Commodity Insights, and Dow Jones Indices. Historically, the company has generated over half of its revenue from its ratings segment.  But, in 2020, S&P Global merged with IHS Markit in a $44 billion deal, allowing the company to diversify its revenue stream and expand into intelligence. Today, Market intelligence is the largest segment representing 35% of total revenue while ratings segment accounts for 23% of revenue. The company’s business shift over the last few years has decreased its reliance on ratings and increased its exposure to markets with higher growth prospects, which includes data and indices within the financial industry. The total addressable market for market intelligence is estimated to be $70 billion. SPGI’s current penetration rate in the market intelligence market is a mere 6% which leaves significant opportunity to expand its business. 

For the fourth quarter the company reported revenue of $2.94 billion, with recurring revenue accounting for 76% of the total. With a significant portion of recurring revenue, the company is better able to withstand a market downturn, which occurred last year when the ratings segment declined -30% as issuance volume cratered. Despite the decline in ratings revenue, both indices and mobility segments grew by 14% and 9%, respectively. The company expects revenue growth of 5% in 2023, a strong rebound from previous years. S&P Global stock is -20% off its all-time high and is trading at a PE ratio of 34x. This current valuation is highly discounted to its peers.  Moody’s, MSCI, and Morningstar currently trade at an average PE ratio of 58x. We believe S&P Global has plenty of growth opportunities ahead through high demand for market intelligence and index data while offering significant downside protection from a weakening economy through its recurring revenue.

Qualcomm [QCOM]

Persistent supply chain issues in both the inputs and final assembly of semi-conductors, combined with a sharp decline in demand, has led to the perfect storm of under supply of semiconductor chips shifting to oversupply in less than six months.  The growing supply-demand imbalance has contributed to a broad selloff in semi-conductor stocks of nearly -50%.  After the upcycle led to a 32% increase in revenue for the previous year, excess capacity means that revenue for QCOM will decline this year.  Looking forward, we are modeling lower growth that results in a lower valuation of the stock.  QCOM is currently trading at 9x earnings and 3x sales, the cheapest it has traded in 10 years.  We believe this mark down in value combined with its growth potential provides an entry point for investors. We would concede that the handset business has largely become a low growth, commodity business for the company but also provides stable free cash flow for investors.  That investment has largely been focused on the auto industry and the increasing connectivity needed with the vehicle.  QCOM has recently landed deals with both Honda and BMW to produce processors for their infotainment systems.  We expect the auto segment to produce $30 billion of revenue over the next 5 years and push QCOM into a dominant position with auto connectivity due to their technological advantage. 

This report is published solely for informational purposes and is not to be construed as specific tax, legal or investment advice.  Views should not be considered a recommendation to buy or sell nor should they be relied upon as investment advice.  It does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual investors.  Information contained in this report is current as of the date of publication and has been obtained from third party sources believed to be reliable.  WCM does not warrant or make any representation regarding the use or results of the information contained herein in terms of its correctness, accuracy, timeliness, reliability, or otherwise, and does not accept any responsibility for any loss or damage that results from its use.  You should assume that Winthrop Capital Management has a financial interest in one or more of the positions discussed.  Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur.  Winthrop Capital Management has no obligation to provide recipients hereof with updates or changes to such data. 

© 2023 Winthrop Capital Management



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