Inflation hovered near a 40-year high for the past year, causing the Federal Reserve to raise interest rates at their fastest pace in four decades. Many economists worry these actions will inadvertently tip the economy into a recession, and that fear led to a sweeping downturn in the stock market. As a result, the three major U.S. indexes -- the S&P 500, the Nasdaq Composite, and the Dow Jones Industrial Average -- all dropped into a bear market earlier this year.
But it's not all bad news. Inflation has now decelerated for four consecutive months and 30% of economists surveyed by The Wall Street Journal think the Fed will start lowering rates by the fourth quarter of 2023, while another 28% expect rates to fall by the first quarter of 2024. Those trends could repair investor sentiment and bring about a new bull market. But even if that timeline fails to pan out, patient investors still have reason to be optimistic.
Every past bear market eventually ends in a new bull market, and there's no reason to believe this one's any different. In the meantime, quality stocks like Microsoft (MSFT 1.57%) and PayPal Holdings (PYPL 2.17%) are trading 29% and 59% off their highs, respectively. That creates a buying opportunity for these two top growth stocks.
1. Microsoft: A provider of mission-critical software and cloud services
Microsoft is the foundation on which hundreds of thousands of businesses are built. Windows is the leading operating system for personal computers and data center servers, and Office 365 is the gold standard in productivity suites. But Microsoft has also carved out a strong position in other business software markets. For instance, Dynamics 365 ranks among the most popular enterprise resource planning (ERP) platforms, and the ERP software market is expected to grow at 11% annually to reach $123 billion by 2030, according to Grand View Research.
Despite the uncertain economic environment, Microsoft reported decent financial results over the past year. Revenue climbed 15% to $203 billion, and free cash flow rose 5% to $63 billion. Unfortunately, management issued disappointing guidance for the second quarter of fiscal 2023 (which ends Dec. 31, 2022), citing weakness in its Windows and advertising businesses. But those troubles stem from high inflation, which is ultimately a temporary headwind. There are still plenty of reasons for shareholders to be optimistic.
For instance, research company Gartner recognized Microsoft as a leader in several cybersecurity verticals, including endpoint protection, access management, and security information and event management. Better yet, Microsoft grew its security customer base by 33% to 860,000 in Q1 of fiscal 2023, and its strong market presence means the company should benefit greatly as the cybersecurity market continues to grow. Grand View Research says cybersecurity spend will increase at 12% annually to reach $500 billion by the end of the decade.
Microsoft Azure is the second largest public cloud, and it's gaining market share due to expertise in database systems, developer tools, machine learning software, and hybrid computing solutions. In the most recent quarter, Azure accounted for 22% of global cloud infrastructure spend, up from 21% in the prior year. That momentum positions Microsoft to be a key player in cloud computing for years to come, and the market is expected to grow at 16% annually to reach $1.6 trillion by 2030.
Finally, Microsoft acquired ad tech company Xandr last year, and that move helped it score a major partnership with Netflix this year. Microsoft is the exclusive ad tech vendor behind Netflix's new ad-supported tier of its streaming service. That could make the company a key player in online video advertising, a market that will grow at 14% annually to reach $362 billion by 2027, according to research company Omdia.
Microsoft has several large market opportunities, and shareholders can reasonably expect double-digit sales growth through the end of the decade. Shares look reasonably priced at 9.1 times sales. That's why this growth stock is a buy.
2. PayPal: The most accepted digital wallet in North America and Europe
PayPal operates a two-sided payments network that provides financial services to businesses and individuals. Its merchant-facing platform enables businesses to engage buyers, accept payments, and prevent fraud across physical and digital stores. And its consumer-facing digital wallets enable users to discover shopping deals, earn interest, access credit, and spend money online and in person.
That two-sided strategy sets PayPal apart from most payment processors. It gives the company insight into consumer behavior and shopping preferences, which can drive sales for merchants. More broadly, it allowed PayPal to build trust on both sides of the transaction, and trust is crucial in the financial industry. According to management, consumers are "two times more likely to shop" when PayPal is a checkout option.
Those advantages put PayPal in rarified air. It's the most accepted digital wallet in North America and Europe, and it was the most downloaded mobile finance app worldwide in the first half of 2022, according to Apptopia.
After a rocky start to the year, PayPal recently reported solid third-quarter results. Revenue increased 11% year over year to $6.8 billion, and free cash flow climbed 37% to $1.8 billion. But the most exciting updates were the new ties with Apple and Amazon. By year-end, merchants will be able to use Apple's Tap-to-Pay service within the PayPal and Venmo iOS apps, and people will be able to add PayPal- and Venmo-branded payment cards to their Apple Wallets in 2023. Additionally, Venmo is now a payment option on Amazon.
Presently, PayPal puts its addressable market at $110 trillion, and it has tailwinds working in its favor. Global digital wallet users will grow 53% to 5.2 billion by 2026, according to Juniper Research. During that time period, digital wallets will take share from cash and payment cards in both physical and digital stores, according to Worldpay.
With shares trading at 3.5 times sales, a discount to the three-year average of 9.3 times sales, this growth stock is worth buying.
