It's no secret some growth stocks have been underperforming the market lately. Some are even down more than 50% from their all-time highs.
However, a few of these stocks are only beaten down due to sentiment, not business outlook. If you can find a thriving company whose stock has gone out of style with Wall Street, purchasing shares at a discount can provide superior long-term investment results.
Two stocks that are out of favor but are still thriving are Alphabet (GOOG 0.79%) (GOOGL 0.63%) and Adobe (ADBE 0.87%). These aren't two high-flying, unprofitable tech stocks. Instead, they are two established players with substantial cash flows. Buying these two stocks now could provide investors with fantastic returns over the next five years.
Image source: Getty Images.
1. Alphabet
While Alphabet has many business segments, it primarily relies upon advertisement revenue derived from its Google search engine and YouTube video sharing platform. These two segments brought in $39.6 billion and $6.9 billion in revenue, respectively, during the first quarter of 2022 alone. Along with its Google Network and Google Other divisions, they brought in nearly $23 billion in net income, up 17% year over year.
With great results like this, investors may be wondering why the stock is trading at a mere 21 times earnings, the lowest it has ever traded for as a public company. The reason? A possible U.S. recession.
The same catalyst that makes Alphabet an excellent investment during the good times is also the same one that hurts it during a recession: advertising. Historically, advertising budgets are cut during a recession, making companies dependent on ads vulnerable. A Bloomberg Markets Live survey found that 48% of investors expect the U.S. to fall into a recession by 2023.
A recession is marked by two straight quarters of negative GDP growth. With GDP falling 1.4% in Q1, the U.S. is already halfway there.
However, even if a recession does occur, it likely won't last wrong. The negative GDP growth was primarily attributed to falling private inventory investment, indicating that inventories are rising to normal levels. This would indicate supply chains are reverting to normal flows, which would boost the economy.
Alphabet has some of the most lucrative advertising space across the internet, making it one of the last places advertisers will cut dollars. If the U.S. doesn't enter a recession, Alphabet will bounce back and continue delivering impressive financial results. At its current valuation, this stock could easily double in three years.
2. Adobe
Adobe provides several invaluable creative software platforms used by nearly every business. Its programs like Photoshop and Illustrator are taught in high schools and universities across the U.S. as the industry standard for many creative fields. Adobe also has an e-signature segment that gives it access to the massive document management space.
Its fiscal 2022 first quarter (ended March 4) saw a slowdown in revenue, with sales only growing 9% year over year. However, when this number is adjusted to exclude an extra week in Q1 of fiscal 2021, this metric climbs to 17%. The outlook for Q2 was solid, with 13% sales growth and 9% non-GAAP earnings growth expected. Management also projected an even stronger second half of the year, making now a prime time to take a position in Adobe's stock.
Similar to Alphabet, Adobe has a historically cheap valuation, as seen in the chart.
ADBE Price to Free Cash Flow data by YCharts
While Adobe's valuation fall can be attributed to slowing revenue growth, if this value reverts to a more normal trend (like management is predicting), Adobe's valuation will likely rise. Combined with its growing revenue stream, Adobe is a strong candidate to outperform the market and double your money within three to five years.
Another factor boosting Alphabet and Adobe's potential is stock buybacks. Both companies use this tool to reduce the number of shares outstanding, making each share more valuable. As of their last earnings announcements, Alphabet and Adobe have the authority to repurchase $70 billion and $10.7 billion in shares, respectively. This amount is enough to repurchase 4.5% of Alphabet and 5.6% of Adobe's market cap.
A solid growth outlook, low valuations, and stock buybacks are a great combination when looking for stocks with the potential to double. You'd be hard-pressed to find two better values than Alphabet and Adobe in today's market.
