The market has turned downward over the last few weeks as interest rates have continued their rise. Investors wonder how long the economy will stay strong as student loan payments resume and higher borrowing costs make it harder to buy a car or home, or even pay for school.
I think the top stocks in October will come from a point of financial strength and can generate long-term value for shareholders. That's why NextEra Energy Partners (NEP +1.92%), Dropbox (DBX 2.04%), Zillow (Z +1.82%), and PayPal (PYPL +1.28%) are all great stocks to buy today.
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The utility Wall Street gave up on
Utility stocks have been absolutely hammered by higher interest rates over the past few months, and NextEra Energy Partners has seen the market turn on it in just the first few days of October. But I think that's missing the forest for the trees.
In late September, management announced that they were adjusting expectations for dividend growth and equity needs. Instead of a 12% to 15% increase in the dividend each year, management now sees a 5% to 8% increase with a target of 6% as it uses more cash to pay down debt that will need to be refinanced at higher interest rates.
Asset sales are also on the table, with pipelines that aren't core to the portfolio expected to be sold.
Even after all these changes, NextEra Energy Partners projects a $3.52 annualized distribution rate at the end of 2023, which means the stock yields 15.6%. This is a company with decades of visibility to the cash flows from the business and a history of adding value for shareholders, so I think it's a great buy today.
An overlooked cloud giant
Dropbox is a well-known name, but it's a very overlooked company on the market. It isn't high-growth compared to some tech companies, and it doesn't release flashy new products. But it has low sales and marketing costs given the self-serve nature of the business. You can see below that this is a cash flow machine that's using that cash to buy back stock.
DBX Free Cash Flow data by YCharts
The stock is relatively cheap too, with shares trading for 15 times trailing earnings and management targeting $1 billion in free cash flow long-term.
I think the next few years will be defined by companies with financial discipline being able to invest in their businesses, while companies that invested too much in money-losing growth will get pinched. Dropbox has the products to continue to be a cash flow business. That'll serve investors well and potentially even give Dropbox the opportunity to acquire financially weakened competitors in a down market.
The best way to invest in housing today
The housing market has gotten crushed in the past year, but Zillow is still holding up well. The company is generating positive cash flow and has a balance sheet with a net cash balance of $1.65 billion.
Z Free Cash Flow data by YCharts
This isn't the same company it was a few years ago, either. A lot of risk has been taken off the table as the iBuying business was shut down, and we have now seen results in a very weak housing market. But Zillow's position as a platform realtors use to reach buyers is now critical to their success, so Zillow keeps raking in revenue.
I think the upside is Zillow generating more revenue when housing (eventually) recovers, and its cost discipline coming out of this market should give operating leverage to the company's growth.
Down but not out
Few companies have been thrown out by the market like PayPal over the past year, but that doesn't mean the company is in trouble. You can see in the chart below that PayPal is still generating a significant amount of cash. It's buying back shares, and after a couple of rough quarters, we are seeing a lot of payment processing companies renew their focus on profitability.
PYPL Free Cash Flow data by YCharts
Most of PayPal's current problems are of its own making. The company undercut competitors on price to win business, which is pressuring margins right now. But that could reverse as PayPal, Adyen, and others realize it's not profitable to grow at all costs.
Meanwhile, PayPal has ingrained itself as a critical financial tool for businesses and consumers, a position that will be hard to break.
I think we're at a low point for PayPal's margins, and the market sentiment will turn once free cash flow increases. When that happens, investors will own even more of PayPal after recent buybacks.
Great opportunities today
The theme here is that each of these companies has positive free cash flow or, in the case of NextEra Energy Partners, long-term contracts that provide financial visibility. In a market where interest rates are rising and the sentiment is becoming more skittish, I want to own companies that are starting from a position of strength.
