After a positive start in January, the S&P 500 has sold off since the start of February and is now down 12.5% over the last year. Given the broader market index dip, it makes sense to start looking to buy some stocks with excellent long-term growth prospects. Data center equipment company Vertiv (VRT 3.70%) and Google owner Alphabet (GOOG 2.65%) (GOOGL 2.81%) are two great stocks to consider.
Vertiv looks good on a risk/reward basis
Based on management’s full-year 2023 guidance, Vertiv stock is a great value. For example, management is expecting 14% to 17% organic revenue growth, adjusted free cash flow (FCF) of $300 million to $400 million, and adjusted diluted earnings per share (EPS) of $1.17 to $1.27. The midpoint of guidance puts Vertiv on a forward price-to-FCF multiple of around 14 times FCF and a forward price-to-earnings multiple of less than 11 times earnings.
Moreover, given the long-term demand growth in Vertiv’s core end market of data centers and digital infrastructure equipment, Vertiv’s stock looks like a no-brainer.
That said, there’s a reason why Vertiv’s stock trades so cheaply. It probably comes down to the fact that it missed FCF guidance in its fourth quarter. Management had forecast a year-over-year improvement of $242 million to $292 million for Q4, only for the figure to come in at an improvement of $135 million. The fear is that Vertiv may be seeing some delayed collections and advanced payments for orders that could cancel in 2023.
Investors will be watching management’s first-quarter FCF and working capital numbers closely. The guidance is for an adjusted outflow of $75 million and a working capital improvement of $15 million. If management hits these numbers and maintains full-year guidance, I think the stock is likely to move materially higher.
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 of the leading data center companies continue to see rising occupancy and utilization rates.
For example, Equinix‘s utilization rate in the Americas was 80% in the fourth quarter compared to 76% in the same quarter a year ago. Its Asia utilization was up to 83% from 79%, and Europe, Middle East, and Africa were flat on 83%. Similarly, Digital Realty Trust‘s occupancy rate was 84.7% in Q4 compared to 83.6% in the same quarter of 2021 , and its management expects to end 2023 on 85% to 86%. Rising occupancy rates imply more investment is needed to build capacity, and that’s great 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 like the cloud/hyper-scale market, which includes companies like Microsoft’s Azure, Amazon Web Services, and Google Cloud.
Indeed, Google Cloud’s growth (revenue up 32% year over year in Q4 to $7.3 billion) is a key reason to buy Alphabet stock. While the business is still loss-making, its recurring revenue and cash flow model mean it will surely add significant amounts of cash flow to the business in the coming years.
Meanwhile, Google’s core search business continues to be a prodigious cash generator. A lot has been made of the decline in Google Search and other advertising revenue of 2% to $42.6 billion in Q4 2022. Still, it’s worth noting that the business actually had “moderate underlying growth” in the quarter if you exclude the effect of foreign currency movements, according to CFO Ruth Porat. It’s also worth noting that slowing consumer spending usually leads to advertisers pulling back on spending — a situation that’s likely to reverse when interest rates finally stop rising.
Wall Street analysts have Alphabet’s FCF rising from $60 billion in 2022 to $70.6 billion in 2023 and topping $100 billion in 2025. Given that Alphabet is also set to hold $122.5 billion in net cash at the end of 2023, it’s a company that will generate and hold vast amounts of cash in the coming years. That cash can be put to good use in the form of growth-enhancing investment and supporting Google Cloud’s march to profitability, so there’s considerable upside for the stock.