Investing in 2023 is “really about quality,” Lori Keith, director of research and portfolio manager at Parnassus Investments, tells Fortune. That means owning high-quality companies “that not only can weather a deeper, more prolonged recession, should we see that, but also be able to participate when we do finally see a reversal” in the Federal Reserve’s aggressive policies, which have thus far pained the markets with its campaign of interest rate hikes to tame inflation.
That’s why Eric Schoenstein, a managing director and portfolio manager at Jensen Investment Management, has been tweaking his thinking when evaluating stocks. With war in Ukraine and persistently high inflation, and likely more rate hikes ahead, “I don’t think this is an environment where top line growth is as easy to achieve, one; and two, as relevant, because it’s a slow growth environment to begin with. And I think that’s going to be with us for a period of time,” he tells Fortune.
With that backdrop in mind, Fortune asked three top portfolio managers for their best stock picks for 2023. The stocks run the gamut from defensive staples to bets on emerging markets, but the companies on this quarter’s list tend to have a few superpowers to help them weather the coming year, including, for many, business models that have lots of recurring revenue or long term contracts, strong balance sheets, and pricing power. And you won’t find as many tech companies in the bunch, as these experts are seeking stable growth and margins as investors brace for—deep breath—a new year.
The steady powerhouses
If a recession is in the cards for 2023, money managers believe businesses with steady revenue streams that provide crucial or sticky services should perform well for investors.
A favorite of Keith’s for years, Republic Services (RSG, $130) is the second-largest waste management company in the U.S. She argues that in rough times it “provides that degree of defensiveness given its position in the market,” adding that the company has a “very significant amount of recurring, annuity-type revenue.” In fact, about 80% of its model is supported by this recurring revenue for services that are “mission critical” to “both commercial and residential customers. It has over 95% customer retention rate within its contracts, which are typically multiyear,” with inflation (consumer price index) escalators built in that allow Republic to “raise pricing as they’re absorbing additional costs themselves,” Keith says. She also applauds the company’s management with capital allocation, and points out that it has been investing in acquisitions, like the 2022 purchase of US Ecology, another waste management firm: Republic is “growing through that direction as well.” Trading at around 26 times the next 12 month’s earnings, the stock isn’t necessarily cheap, but analysts project that Republic Services can grow earnings by nearly 17% in the 2023 calendar year—a hearty clip in a slower growth environment. And if a recession does befall investors next year, “because the contracts are long-term, there’s really no ability in a shorter-term sort of downturn to modify those contracts,” she notes.
A similarly defensive earner, Otis Worldwide Corp (OTIS, $65) is an elevator equipment manufacturer that, though not in “exactly a super glamorous industry,” is what Keith considers a “very profitable” and “very good business in terms of being able to generate consistent profits and cash flow.” Otis is the leading firm in the industry worldwide, and its business is split between new equipment sales and “a significant amount of service revenue associated with servicing these elevators and adding new technology,” she notes. There are a lot of aging elevator systems that need to be replaced in commercial buildings, so there’s a “nice replacement cycle in front of us,” Keith points out. Meanwhile those elevators need to be serviced and maintained, which provides recurring revenue for Otis and “allows them to have high visibility into their earnings and profits,” she says. While Keith points out that the company “has not been immune to the challenges with higher commodity costs and FX headwinds,” she believes it is “well-positioned” to keep steadily growing earnings. The firm also doles out a nearly 2% dividend yield, and year-to-date has repurchased $400 million worth in shares. Although revenues aren’t expected to go gangbusters in 2023, the Street expects Otis to grow earnings per share by a hefty 14% next year. Trading at around 20 times estimated forward earnings, Keith believes investors can take a ride on the “very wide moat business”—hopefully up.
But going for more dependable, steady companies doesn’t require sacrificing growth, according to Jensen’s Schoenstein: “I think it’s more about understanding how they grow and what kind of resilience is built into that growth,” he argues. Schoenstein still believes Microsoft (MSFT, $225), which was also featured on Fortune’s stocks to buy for 2022 list, could fit the bill for investors. “Because it’s commercially focused, it’s not so much about the economy growing for them as it is about their business customers continuing to need their services,” Schoenstein points out. “Unless you have large scale business failures, Microsoft’s services are still going to be in pretty strong demand.” That includes the tech titan’s enterprise office and productivity software as well as its powerhouse cloud unit, which “are actually allowing companies to be more efficient, which helps them in recessionary times,” he notes. “That is less likely to be a focus of any spending cuts on the technology side by their commercial customers.” Analysts project Microsoft can grow revenues by about 11% in their fiscal year ending June 2023, and 14% the following fiscal year. And despite the economic backdrop, the firm recently reiterated their 2023 guidance for double-digit top line growth, a positive sign to the Street. Trading at about 23 times forward earnings, Microsoft also doesn’t come nearly as expensive as some of its growthy tech peers.
Elsewhere, Parnassus’ Keith believes Sysco (SYY, $73) also fits into the “recession proof bucket” as the world’s largest food distributor, servicing the likes of restaurants, hotels, and hospitals. Keith notes they’ve benefited from having “very significant market share” in the U.S., which she says is about 17% of the fragmented field. That position “creates a really nice opportunity as Sysco is investing in their business in terms of technology, in terms of their employees, [and] having the ability to service customers more efficiently,” which should help them gain even more market share. She also points to the firm’s track record for surviving downturns well, noting they saw “fairly minimal disruption from an earnings and top line perspective” during the 2008 financial crisis, so “there’s a really strong case here that the company can weather additional downturns.” Although recessions often prompt consumers to spend less money eating out, Keith notes that, in combination with demographic changes, “people continue to exercise food away from home.” And if inflation does begin to meaningfully cool next year, that should also help with things like fuel costs for Sysco. Analysts expect the company to post a whopping 56% earnings per share growth in the next fiscal year ending June 2023, and the stock trades at a reasonable 17 times next 12 months earnings with a 2.7% dividend yield.
The classic recession stocks
In difficult times, it can be comforting—and prudent—to return to what you know. And some money managers recommend doing just that, highlighting a couple more classic recession stocks to weather the tougher growth environment of 2023.
Schoenstein likes longtime favorite TJX (TJX, $64), the off-price retailer whose stores include T.J. Maxx and Marshalls. TJX falls into the category of the “treasure hunt” stores, where more budget-conscious customers search for deals. He points out that there’s a “pretty good track record of strong consumer trade-down spending in recessionary periods,” which should be a boon for TJX. Schoenstein argues that if we do go into a recession, there might be more “buying opportunities for product” to put into TJX’s stores, and believes TJX should be able to leverage its buying power and network to “take advantage” of “better merchandise availability” from department stores’ discounts to clear inventory. Morningstar analyst Zain Akbari is of the same mind, writing in a September note that “we believe TJX and the rest of the off-price sector are better suited than most retailers to endure disruption from the pandemic and an unsettled economy.” Though its growth prospects aren’t astronomical, the Street expects TJX to grow earnings per share by about 9% next year, and more than double the following year; the stock, meanwhile, which has sold off about 15% so far in 2022, trades at 19 times forward earnings, and comes with an almost 2% dividend yield.
And for investors who are really wringing their hands about the possibility of a 2023 recession, Schoenstein recommends tried-and-true Procter & Gamble (PG, $124), what he considers “your classic consumer staple that ought to be pretty good during a recession.” The consumer goods titan’s business focuses on “personal care, grooming, home care, fabric care, baby care. I think those things are all sort of going to continue to be necessary,” argues Schoenstein. “You know, people don’t stop spending on those things.” And even if tougher times and sticky inflation prompt consumers to look for the cheaper brand on the shelf, Schoenstein notes, P&G has differently priced brands within its family of products.
As a large holding in the S&P 500, the stock has declined over 20% so far this year, as has the index. But Schoenstein says P&G is still “showing strong, resilient, organic revenue growth,” and believes that that helps him “look a little bit through” hits to the business owing to currency issues, with the U.S. dollar soaring compared to other global currencies. “They are getting pricing to offset some of the inflationary issues and cost pressures,” he says. Both earnings and revenue growth are expected to be muted next year, but Schoenstein highlights P&G’s mighty 3% dividend yield as something that could help its case for investors: “Even if the valuation takes some time to recover,” he notes, if the company posts the anticipated growth, it “will have a better opportunity to maybe stand out in investors’ minds as everything else slows.”
Emerging markets bets
According to Vontobel’s Chelat, “what could surprise people” is “some emerging markets could be quite resilient next year,” in particular places like India and Brazil, which could “show incrementally better growth heading into next year” with “room on the monetary policy side to cut rates.” That could start creating a “bit of a contrast in emerging market growth versus developed market growth next year in certain emerging markets,” he argues.
There, he likes Heineken (OTC:HEINY, $44), the classic beer brand. Though the company is based in the Netherlands, Chelat favors Heineken because it is “quite exposed to some attractive emerging markets such as Vietnam and Brazil and Southeast Asia, which are seeing improving growth and also reopening benefits…[as] they reopened later than what we’ve seen in developed markets” from the pandemic. He also believes those markets structurally “should be in better shape in 2023 and beyond” than the growth-challenged U.S. market. Chelat argues the company “can be quite resilient” in more troubled times, pointing out that its “pricing power [has] come through very strongly in the second quarter,” with organic volume growth in the upper single digits (though CFO Harold van den Broek cautioned in the firm’s 2022 midyear results in August that “we continue to observe a challenging global environment and an uncertain economic outlook.”) Analysts estimate that Heineken can grow revenue in the roughly 8% range and earnings per share by about 9% for the next calendar year, while the stock is expected to trade at a reasonable 18 times forward earnings.
Chelat is also bullish on India, particularly in the wake of several system reforms the country is “benefitting from.” He points out India’s GDP is estimated to grow at around 5% next year, which, though slowing, will likely outpace the U.S. and other countries. In particular he believes HDFC Bank (NYSE:HDB, $56), a longtime holding of Vontobel’s, is still “taking market share in their core segments, in mortgages in particular” and, along with its 2022 merger with HDFC Ltd., India’s leading housing finance firm, believes it can “increase their market share further post the merger,” which “will allow HDFC to sell mortgages across a much wider-branch network and leverage HDFC Bank’s deposit strength.” Chelat also argues the firm is in an “attractive market which is underpenetrated in terms of mortgage growth and other consumer credit growth.” The Street is optimistic, predicting nearly 20% revenue growth for the 2023 fiscal year ending in March 2024, while earnings per share could grow roughly 17% in the same timeframe. Trading at around 17 times estimated next 12 months’ earnings, the stock is among the cheaper picks on Fortune’s list—a potentially nice entry point if investors are willing to bet growth in emerging markets might outpace that in the U.S.
All stock prices calculated as of Oct. 11, 2022.