As we start the new year, it's a great time to consider adding some fantastic tech stocks to your portfolio.
Three Motley Fool contributors have shared their top picks for companies that are set to thrive in the coming months and beyond, and we'll be exploring those ideas here. If you're a savvy investor searching for a company specializing in data center infrastructure software, a digital services and software veteran, or a power and sensing semiconductor leader, we've got you covered.
Someone will need to help manage all that new data center infrastructure
Nicholas Rossolillo (Dynatrace): Cloud computing is going bananas right now, even in the midst of deteriorating economic conditions. Next-gen IT operations help companies save money and "do more with less," so cloud spending is poised to remain a top priority in 2023 regardless of what the global economy decides to do. Big organizations, in particular, are behind the curve and need data center upgrades to support their cloud rollout. Tech researcher Gartner (NYSE: IT) predicts that various cloud spending, from infrastructure to the software itself, will increase more than 20% this year and reach nearly $600 billion.
That's why I think Dynatrace (DT -1.98%) makes a lot of sense here. The company specializes in data center infrastructure software and focuses its attention on the biggest businesses around, given the incredible complexity such large operations deal with. Dynatrace's software helps these businesses keep their software running smoothly, and when problems do arise, automates the detection of the root issue and recommends a fix.
It's an incredibly powerful suite of software, and Dynatrace has been steadily growing its subscription base. Annualized recurring revenue (ARR) grew 23% year over year in the last quarter to $1.06 billion, or up 30% year over year when excluding the negative effects of currency exchange rates, a side effect of the Federal Reserve's interest rate increases in 2022. In the quarter that just ended in December, Dynatrace had predicted ARR to increase at least 17% year over year, or at least 23% when excluding exchange rates.
War and an energy crisis in Europe are the causes of Dynatrace's more sluggish outlook headed into the New Year, but clearly, it is still winning over new customers as the cloud era takes over. But Dynatrace's ability to turn a healthy profit along the way is even better than robust top-line growth, both on a GAAP net income and free cash flow basis. Dynatrace expects to be able to increase these profit margins even more in the coming years.
Data by YCharts.
After getting a beatdown from the bear market, Dynatrace trades for 35 times trailing-12-month free cash flow as of this writing. It's still a premium, sure, but one this infrastructure software company has earned given its successful focus on highly profitable growth. I think Dynatrace stock will do well in 2023.
Perhaps the biggest winner you've never heard of
Anders Bylund (Amdocs): Digital services and software veteran Amdocs (DOX -0.78%) focuses on the telecommunications, media, and financial services sectors, all of which have gone through serious challenges over the past year. Yet Amdocs' sales growth accelerated in 2022 and the stock rose by 22% over the past 52 weeks:
The company is eyeing continued growth in vibrant markets such as 5G wireless network management, digital billing and payment systems, and low-code app development platforms. Amdocs helps clients set up and manage robust solutions for managing digital content licenses, billing services, wireless network provisioning, and more. The company is particularly good at automating common workflows.
This stock isn't hanging out in Wall Street's bargain bin, as it trades at 20.6 times trailing earnings today. However, those bottom-line profits are expected to increase in 2023, and the forward-looking P/E ratio stands at just 14 times expected next-year earnings. And as master investor Warren Buffett says: "It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price."
Amdocs aims for increased top-line growth and wider profit margins over the next couple of years. The global rollout of 5G wireless networks plays a large part in these plans. All things considered, picking up a few Amdocs shares at this highly reasonable price should set you up to make money in the long run.
This auto and industrial chip challenger can conquer higher rates in 2023
Billy Duberstein (On Semiconductor): There's a lot of uncertainty in the market right now, especially regarding semiconductor stocks; however, there are some things that are near certainties to happen over the next one or two years.
One is that more electric vehicles will be produced this year than last year, as EVs make up a greater proportion of the auto market. Second, the ongoing decarbonization of the electric grid will progress, as incentives from the Inflation Reduction Act kick in. Third, industrial and manufacturing projects will be increasingly automated, especially as wages rise amid the ongoing labor shortage. While many parts of the semiconductor industry, such as commodity memory chips, are in a terrible bear market right now, power and sensing semiconductors used in automation and electrification applications continue to garner strong demand, with some still in a shortage.
This all plays into the hands of On Semiconductor (ON -1.50%), which garners a majority of its revenue from advanced power semiconductors and sensors used in auto and industrial applications. In its recent third quarter, On generated 40% of revenue from the automotive sector and another 28% from the industrial sector. These two sectors combined grew more than 40% for the first three quarters of 2022, compared with 7.4% in On's other sectors across consumer, data center, and communications chips.
While On's growth is likely to slow from the supply constrained environment of 2022, management still predicts 17% annualized growth for auto chips and 7% annualized growth for industrial chips through 2025, powering 7%-9% annualized growth for the company over that time. Given that On trades at just a P/E ratio 16 and only 13 times 2023 estimates, that's a bargain price to pay for high-visibility, highly profitable growth.
Moreover, On's current management is likely to grow profits even faster than revenue, especially since activist investors took control of the board in late 2020 and installed current CEO Hassane El-Khoury.
Since the fourth quarter of 2020, On has expanded gross margins by about 15 percentage points and operating margins by around 20 percentage points. That incredible profit drive came as On consolidated various subscale manufacturing plants and exited less profitable and more competitive consumer chips. And On's transformation continues, as it's now investing in new 300mm manufacturing capacity for low-cost internal production of differentiated silicon carbide technologies, while outsourcing more common and less differentiated production technologies and packaging services.
The ongoing cost optimization efforts and newfound profitability have allowed On to begin returning cash to shareholders, as it just started up a share buyback program in the second quarter of 2022.
With high visibility, high-single-digit revenue growth, likely greater EPS growth, and just a mid-teens P/E ratio, On is the type of tech stock that can outperform in this new higher-rate environment. I also wouldn't be surprised if the company announced a dividend sometime soon.
