2023 has so far been volatile for the U.S. equity market. The strong bull rally in January seems to have fizzled out on worries about rising inflation and mixed corporate earnings performance. Recent comments from Federal Reserve Chairman, Jerome Powell, highlighting the need for "faster tightening" of the money supply and for higher-than-expected interest rates in the coming months have further affected investor confidence.
Moreover, the collapse of regional bank Silicon Valley Bank and the potential risk of contagion to other financial institutions have also increased the risk of recession.
However, there is still money to be made on Wall Street for long-term investors in the current uncertain economic environment. Investors can put as little as $100 in high-quality and fundamentally strong companies such as Bank of America (BAC 1.48%) or DigitalOcean (DOCN 1.39%) -- so long as the money isn't needed to cover expenses or contingencies -- to start building wealth now.
Bank of America
Although the collapse of regional banks such as Silicon Valley Bank and Signature Bank has rocked financial markets, Bank of America may emerge a winner in these tumultuous times. According to the Financial Times, a large number of customers are now shifting accounts to larger banks such as BofA, JPMorgan Chase, and Citigroup, which are considered "too big to fail" lenders. Bloomberg estimates BofA has received over $15 billion of deposits in the aftermath of the Silicon Valley Bank collapse.
BofA also had a large and diversified deposit base worth $1.93 trillion, despite the $8 billion deposit decline at the end of the fourth quarter. While the bank also saw a $24 billion decline in consumer deposits to $1 trillion, at the end of the fourth quarter, these are very sticky deposits and hence run a very low risk of significant drawdown even in the current precarious environment.
Additionally, Bank of America also stands to benefit significantly in the high interest rate environment. despite deposits becoming more expensive. The bank can control its interest expense since over 34% of its total deposits are noninterest-bearing--which helps control costs. In the fourth quarter, net interest income (NII) rose year over year by 29% to $14.8 billion.
BofA's share prices have been depressed even prior to the current banking crisis. Investors have been worried about the rising possibility of credit losses in a slowing economy. However, the fears seem slightly exaggerated from BofA's perspective. Although the bank has set aside loan-loss provisions of $1.1 billion , its net charge-off ratio in the fourth quarter was only 0.26% --up 6 basis points on a sequential basis but still below pre-pandemic levels.
BofA's Common Equity Tier 1 (CET1) ratio, which measures bank's common equity as a percentage of risk-weighted assets, was 11.2% in the fourth quarter, well above the requirement of 10.9%. Hence, the bank is well-capitalized and has enough liquidity to fund its financial activities even in a difficult macroeconomic environment.
Bank of America is highly profitable. The company also pays an attractive dividend yield of 3.17% with a dividend payout ratio of just 27%.
Against the backdrop of a high-interest rate catalyst, robust capital position, and a safe and attractive dividend payout, Bank of America seems a no-brainer buy to me.
DigitalOcean
Cloud infrastructure player DigitalOcean has successfully carved a niche for itself in a space dominated by technology behemoths such as Alphabet, Amazon, and Microsoft, thanks to its focus on underserved customer segments such as developers, start-ups, and small and medium businesses.
DigitalOcean has differentiated itself from the competition by offering transparent, easy-to-implement, and affordable cloud-native infrastructure and platform tools. In addition, the cloud solutions company also provides personalized support to its clients, irrespective of their scale.
The company reported a 34% year-over-year jump in revenue to $576 million in 2022. However, it has hardly scratched the surface of its $98 billion target addressable market.
DigitalOcean is also re-prioritizing profit and cash flows over top-line growth in the current precarious macroeconomic environment. The company now expects fiscal 2023 revenue of $700 million to $720 million, implying year-over-year growth of 23.2% at the midpoint -- slower than the growth rate seen in previous years. DigitalOcean has pushed back the $1 billion revenue target from fiscal 2024 to fiscal 2025. However, the company expects the free cash flow margin to grow from 13% in 2022 to a range of 21% to 22% in 2023. The company is also close to becoming profitable under Generally Accepted Accounting Principles (GAAP) in the coming years.
Similar to the bigger players, DigitalOcean is also exposed to the risk of a protracted slowdown in corporate spending. However, barring these macro challenges, the company has solid fundamentals and is backed by secular growth tailwinds in the cloud computing space. Hence, with the stock down by over 45% from its all-time highs, this may be a good time to start a small stake in the company.
