Last week, we published the Top 5 Stocks of 2022 on Forbes. Below, we expand on that list to include an additional 5 Stocks for our Essentials Members. We believe this is one of the most important pieces we can write – not because we are looking to buy these exact stock tickers in 2023 – but because it’s sending an important message about what stocks performed well in the new macro conditions of 2022.
The number one mistake that tech investors are making is to white knuckle the idea that growth will lead. We know this mistake well as we made this mistake ourselves before pivoting hard in April/May of last year to overhaul our tech portfolio for bottom line strength. This will change again but we think it’s premature to assume it will happen in H1 2023.
What you’ll note below are a few things:
- The market greatly rewards expanding margins and increasing profitability:
o Gross Margin should be flat to expanding
o Operating Margin should be flat to expanding
o Net profits should be flat to expanding, this is expressed by earnings per share growth (EPS) - As we move into Q1 earnings, the above three-line items can make or break an earnings report. Our plan is to build key positions that demonstrate strength in these line items throughout this upcoming earnings season. This is playing it safe and assuming top line growth is not in the driver’s seat yet. It also means we believe there could be more deceleration to come on the top line across many otherwise-solid tech companies. It’s hard to guess which ones will decelerate and we prefer to make companies prove themselves and earn a spot in the portfolio.
- The market rewards accelerating revenue. You can argue this is a no-brainer but with so few tech companies being able to accelerate revenue right now, this requires a sharp eye as tech investors are hung up holding on to favorites/darlings that reported decelerating revenue in 2022. We allow some variance here but it’s better to step aside if the revenue is decelerating too much and return to a stock when it can prove it’s found a revenue bottom in its fundamentals.
This means, we’ve made a choice to put risk above reward. We could be wrong and growth could go on a big winning streak. We feel we are agile enough to recognize if the leadership changes, and if so, we will change our strategy at that time. For now, every signal we follow proves that earnings are in the driver’s seat. We’ve published on this throughout many of our broad market and earnings coverage articles, for example:
- Knox has stated the Dow is the leading broad market index to watch. He has also discussed that the FAANGs are not the leaders, which also marks an important change. Overall, this means growth stocks are not truly in the drivers seat right now over value.
- I covered the slowing growth in cloud for Essentials here. I fully believe some cloud stocks will provide positive and negative bottom line surprises this year – I don’t know which ones those will be given the weak bottom line cloud characteristically has. We prefer to wait and see, and then build those that can meet the bullet points outlined above.
- We’ve covered the bottom line strength in other sectors here — for example, building semi positions despite negative new headlines.
The first half of the article below as published in Forbes. We’ve copied the article in full. The second half is for Essentials Members only. Please note, although we disclose the positions we own to adhere to disclosure guidelines, these positions may change at any time. For example, at time of writing we owned Enphase and we have recently cut back on Enphase. The disclosure below is not to be relied on as “Stock Picks” for Essentials Members. We provide a stock pick once per month and if that stock pick changes, we will cover our new positioning and new fundamentals outlook. For example, we will cover AMD and Netflix earnings reports and let you know if we are changing those positions.
Top 10 Stocks for 2022
By Royston Roche and I/O Fund Team
Original copy from Forbes starts here:
In this analysis, rather than prognosticate on the top stocks of 2023, we think it’s more productive to go back and review the stocks that performed well under new macro conditions in 2022. This exercise helps to inform tech portfolios for the upcoming year as investors can reasonably assume 2023 will look more similar to 2022 than the preceding years.
2022 was a very volatile year for the stock market with rising rates, inflation, and geopolitical tensions leading to sudden sell-offs. All three main U.S. indices ended the year with negative returns, with Dow Jones Industrial Average down 6.86%, S&P 500 index down 18.11%, and Nasdaq down 32.54%. Despite the indexes being in the red, some stocks greatly outperformed the broad market.
We think it’s important to pause and draw some parallels around the stocks that performed well in 2022 to form an opinion on what might perform well in 2023. This is assuming macro will be more similar to 2022 than the preceding years, which is a reasonable assumption to make at this time. Below, we review the [top ten] stocks of 2022. These stocks were chosen based on their price action and strong fundamentals. Choosing a [top 10] means many great stocks were left off this list, yet this sample helps to form conclusions around how 2022 was a different trading environment from years past.
Source: YCharts
Super Micro Computer (SMCI)
Super Micro Computer stock had 2022 returns of 86.8% and is the best-performing stock in our tech universe. Below is a chart that shows the quarterly year-over-year revenue acceleration Super Micro posted in 2022, which helped support its 2022 winning streak.
Pictured above is SMCI’s Qly revenue YoY growth. Source: YCharts
The company provides server and storage solutions to data centers, cloud computing, 5G, AI, and edge computing markets. The company was recently added to the S&P MidCap 400 Index and enjoys tailwinds from leading semiconductor companies such as AMD, Nvidia, and Intel.
In the recent earnings call, the founder and CEO of the company, Charles Liang said, “For Intel, we are engaged with many large opportunities with Intel’s upcoming Gen 4 scalable Xeon CPU codenamed Sapphire Rapids. We now have hundreds of early seeding engagements including several dozen early shipments. Similar programs have been executing with AMD, and we have seen very strong demand for our upcoming Genoa CPU based platforms.”
“With respect to NVIDIA, not only do we have the most complete portfolio of systems supporting H100 GPUs, but we have also developed many brand new architectures for the leading Metaverse and Omniverse partners.”
The company’s revenue in the recent quarter, Q1 FY23, grew by 79% YoY to $1.85 billion. The gross margin improved to 18.8% in Q1 FY23 up from 13.4% in the same period last year. The company’s profits have grown steadily with net income of $184 million compared to $25 million in the same period last year. The stock is currently trading at a P/E ratio of 10.3 and a fwd P/E ratio of 8.1.
Source: YCharts
Microsoft (MSFT)
Microsoft was one of the best performing tech mega cap stocks last year ending the year down (28%), compared to Meta and Tesla, which ended the year down (64%) and (65%), respectively. Notably, Microsoft narrowly beat the Nasdaq in 2022.
The company is positioned for outsized growth due to its exposure to secular tailwinds such as Artificial Intelligence (AI), Machine Learning (ML), and the build out of the 5G edge network. Microsoft could take a substantial share of these markets at the infrastructure level due to its relationships with the Fortune 500 and Global Fortune 2000.
In addition to top-down enterprise penetration across the Fortune 500, Microsoft is also focused on developers to help complete Microsoft’s customer cloud strategy. Microsoft addressed its previously poor reputation in open-source communities by acquiring GitHub for $7.5 billion in 2018. Developers help determine the cloud IaaS service an enterprise or SMB customer will choose, so in-roads into this community could help Microsoft hedge the developer favorite, Amazon Web Services.
The company’s Q1 FY23 revenue grew by 11% YoY and down 3.4% QoQ to $50.1 billion.
Operating income increased by 6% YoY to $21.5 billion. Net income was $17.6 billion compared to an adjusted net income of $17.2 billion in the same period last year (adjusted net income in the previous year as the company received income tax benefit last year).
The net profit margin was 35% in the recent quarter.
Microsoft has proven it has many levers it can pull during a tougher macro compared to its mega cap tech peers – primarily seen in the consistency of its profit margin.
Source: YCharts
ASML Holding (ASML)
ASML Holding is benefitting from strong semiconductor equipment demand from the leading foundry companies. As new fabs are built, these companies will need equipment in the coming years. The company’s fiscal year 2022 revenue analysts estimate rose 12% in the last 2 months. The company raised the 2025 revenue guidance to be between €30 billion and €40 billion, up from the previous guidance of €24 billion to €30 billion. The company in its press release acknowledged, “While the current macro environment creates near-term uncertainties, we expect longer-term demand and capacity showing healthy growth.”
The company’s Q3 revenue was €5.8 billion compared to €5.2 billion in the same period last year. The management expects Q4 revenue to be between €6.1 billion to €6.6 billion. The gross margin was 51.8% compared to 51.7% in the same period last year. Net income was €1.7 billion (net profit margin of 29.4%) compared to a net income of €1.7 billion (net profit margin of 33.2%) in the same period last year.
The company has a strong backlog of over €38 billion. The company’s CEO Peter Wennick said in the earnings call, “And as a matter of fact, our 2023 shipment demand is still significantly above our build and shipment capacity for next year. And this is supported by the record bookings this quarter, of €8.9 billion and our largest backlog ever of over €38 billion. Almost 85% of this backlog is for EUV and immersion, which is used for advanced nodes and related wafer capacity expansions.”
Palo Alto Networks (PANW)
Leading cybersecurity company Palo Alto Networks has a strong free cash flow margin, which is rare in the cloud and cybersecurity category. The company has been GAAP profitable in the last two quarters. The company’s revenue in the Q1 FY23 grew by 25% YoY to $1.6 billion, which was above the management guidance of $1.535 billion to $1.555 billion.
The company’s margins are improving. The company reported a GAAP net income of $20 million compared to a GAAP net loss of ($103.6) million in the same period last year. The adjusted net income was $266.4 million compared to $170.3 million in the same period last year. Consistent GAAP profitability is key in this macro environment.
The company reported free cash flow of $1.2 billion (76.6% of revenue) compared to $554 million in the same period last year (44.4% of revenue). Dipak Golechha, CFO of the company, said in the earnings call, “This cash flow performance was largely driven by strong collections in the quarter, that we expected based on the strength of our business in Q4.” The management has guided an adjusted free cash flow margin in the range of 34.5% to 35.5% for the FY23.
Dipak Golechha said, "We exceeded our top-line guidance while generating $1.2 billion in free cash flow and expanding our operating margins," He further added, "We will continue to balance growth with profitability and cash generation to further strengthen our position in the market."
Source: YCharts
First Solar (FSLR)
Solar stocks were the leading sector in tech last year. First Solar ended the year on fire with a return of 72% compared to the (33%) return of the Nasdaq. The sector got a boost from the Inflation Reduction Act of 2022, which we covered last year in our free newsletter when we said:
“The solar industry will benefit since Inflation Reduction Act includes the extension of Production Tax Credits (PTCs) and Investment Tax Credits (ITCs) for the construction of wind and solar projects beginning before January 1, 2025. It means a three-year extension for PTCs and a one-year extension for ITCs.
It also extends the 30% federal tax credits for installing solar panels on rooftops by another 10 years, from 2022 to 2032. Solar installations are eligible for 26% tax credit for installations in 2020 and 2021. It now extends till 2032 for 30% tax credits, and in 2033 the tax credit will be reduced to 26% and 22% in 2034. There will be no tax credit after this period unless Congress renews it. Home battery systems that store energy generated by solar systems for later use will also be eligible for a 30% tax credit.”
First Solar is a leading provider of photovoltaic (PV) energy solutions. It is one of the major beneficiaries of the IRA in the form of solar manufacturing tax credits. The company was also recently added to the S&P 500 index.
The company announced last year its plan to invest $1.2 billion to expand its solar module manufacturing in the U.S. It includes a $1 billion investment for a new manufacturing facility in the Southeast U.S. and $185 million for the upgradation of the existing Ohio facility.
Mark Widmar, CEO of the company, said in the Q3 earnings call, “In our view, by passing and enacting the Inflation Reduction Act of 2022, Congress and the Biden-Harris administration has entrusted our industry with responsibility of enabling and securing America's clean energy future, and we recognize the need to meet the moment in a manner that is both timely and sustainable.”
The company’s Q3 2022 revenue was up 7.8% YoY to $628.9 million. It reported a net loss of ($49.2 million) compared to a net income of $55.8 million in Q2 2022 and $45.2 million in the same period last year. The company benefitted from the gain from the sale of the Japan project development platform in the Q2 2022 and also experienced higher logistics charges in the recent quarter.
Mark Widmar, CEO of First Solar said, “Our focus continues to be on setting the stage for long-term growth, and from this point of view, 2022 has so far proven to be foundational,” He further added, “This year we have developed the potential for our CdTe semiconductor technology by progressing our next-generation Series 7 and bifacial platforms, set in motion plans to scale our global manufacturing capacity to over 20 GWDC by 2025, and secured record year-to-date bookings of 43.7 GWDC with deliveries extending into 2027.”
Taiwan Semiconductor Manufacturing (TSM)
Taiwan Semiconductor Manufacturing was in the news in November after Warren Buffet’s Berkshire Hathaway invested $4.1 billion in the company.
The company has developed market leadership in the foundry industry particularly with advanced nodes, which are nodes defined as 7nm and below. The advanced nodes have strong demand by top design companies, such as Apple and Nvidia, particularly in high-performance computing and smartphones. The company has started the production of 3nm process technology and currently this is the most advanced chip production technology. Samsung is a competitor that has begun production using 3nm technology. However, in the past TSMC has been able to win the business from Samsung due to better yields and economies of scale. Apple constituted 26% of the total revenue of 2021.
TSM’s Q3 2022 revenue grew by 36% YoY and 11% QoQ to $20.23 billion. Wendell Huang, CFO of the company, said, “Our third quarter business was supported by strong demand for our industry-leading 5nm technologies.” This means TSM is maintained strong growth throughout 2022 with 37% in Q2 2022 and 36% in Q1 2022.
The margins are also expanding – TSM’s gross profit was $12.2 billion, with a gross margin of 60.4%, up from 51.3% in the same period last year. This was higher than management guidance of 57.5% to 59.5% as the company benefited from favorable foreign exchange and cost improvements.
The net profit was $9.3 billion compared to $5.6 billion in the same period last year. The net profit margin was 45.8% compared to 37.7% in Q3 2021. Many companies have struggled with rising costs, while TSM has successfully navigated these challenges with cost controls and negotiating better prices with its customers.
In addition to expanding margins, the company generated a total of $18 billion in free cash flow in the last four quarters.
Pictured above: TSM’s expanding net margin. Source: YCharts
Enphase Energy (ENPH)
Enphase has an exceptional product, which is the IQ8 Microinverters, and a strong management team. Enphase was one of the top performing stocks in the Nasdaq last year and for good reason – the company reported accelerating revenue in 2022 across two quarters and has expanding margins. It ended the year with a return of 45% compared to the (33%) return of the Nasdaq. The company is also a beneficiary of the Inflation Reduction Act of 2022. Enphase is seeking new ways to manufacture domestically to take advantage of the Inflation Reduction Act. The company plans to open 4-6 manufacturing lines in the USA by the second half of 2023. The IRA provides a credit of approximately $43 per microinverter manufactured in the United States directly to Enphase.
The company reported Q3 revenue of $634.7 million, up 80.6% YoY. Management guided Q4 revenue of $680 million to $720 million, representing an expected YoY growth of 70% at the mid-point.
The company’s margins are also expanding along with strong revenue growth. The gross margin was 42.2% in Q3 2022 compared to 39.9% in Q3 2021. The operating margin was 21.4% compared to 10.6% in Q3 2021. Similarly, the adjusted operating margin improved from 24.5% in Q3 2021 to 30.6% in the recent quarter.
The GAAP net margin of 18.1% is nearly three times higher than Q3 2021 net profit margin of 6.2%. Analysts on the call were excited to hear about the prospect of Enphase improving its already-good bottom line with IRA credits. The company’s CEO Badri Kothandaraman mentioned in the earnings call, “Once the IRA with details have been finalized and the implementation is clear, the U.S. manufacturing could provide substantial benefits in terms of the production based tax credit.”
Texas Instruments (TXN)
Texas Instruments has a strong net profit margin. The company’s Q3 2022 revenue grew by 13% YoY to $5.24 billion. Operating profit increased by 16% YoY to $2.68 billion. Operating profit margin improved to 51.1% from 49.6% in the same period last year. Net income grew by 18% YoY to $2.3, billion with a net profit margin of 43.8% compared to 41.9% in Q3 2021.
Source: YCharts
In addition to strong margins the company has been generating consistent cash flows. The company’s CEO and President, Rich Templeton, said, “Our cash flow from operations of $9.0 billion for the trailing 12 months again underscored the strength of our business model. Free cash flow for the same period was $5.9 billion and 29% of revenue. This reflects the quality of our product portfolio, as well as the efficiency of our manufacturing strategy, including the benefit of 300-mm production.”
The company also accrued investment tax credit in Q3 from the CHIPS Act. Rafael Lizardi, CFO of the company, said in the earnings call, “Let me now make a few comments on the CHIPS Act that was recently signing to law. The combination of the investment tax credit, the grant as well as funding for research and development will help make the U.S. semiconductor industry more competitive. We accrued about $50 million on the balance sheet in third quarter due to the 25% investment tax credit for investments in our U.S. factories. This will eventually flow some statement as lower depreciation and we will receive the associated cash benefit in the future.”
Box Inc (BOX)
Box was the best-performing cloud stock of 2022 and gave a return of 19%. The company beat analyst estimates on 3 out of 4 occasions last year in both top-line and bottom-line estimates. The company’s margins are improving, which is another reason for the stock’s outperformance.
The company’s revenue in the Q3 FY23 grew by 12% YoY to $250 million. The adjusted gross profit margin was 76.5% compared to 74.7% in the same period last year. Adjusted operating margin improved to 24% from 20.7% in Q3 FY22.
Dylan Smith, co-founder and CFO of the company, said in the earnings call, “Box will be better positioned to continue delivering profitable growth as we scale, exiting next year with an even stronger operating margin model after completing this important transition to the public cloud.”
GAAP net income was $4.98 million compared to a net loss of ($18.2) million in the same period last year. The adjusted net income was $46.6 million compared to $35.4 million in Q3 FY22. Free cash flow was $55 million (22% of revenue) compared to $31.2 million (14% of revenue) in the same period last year.
For those who closely follow cloud, it may be surprising that Box was the top performing stock in the category yet this is sending a strong signal to cloud investors as to what is being rewarded in the current macro conditions – as stated, it’s firmly a strong bottom line is being rewarded. It’s also a strong signal as to the change in paradigm as Box has been a lagging cloud stock for many years when growth was in the driver’s seat.
Indie Semiconductor (INDI)
Indie Semiconductor is benefitting from the growth trend in advanced-driver assistance systems and electric vehicles. The company has a Serviceable Addressable Market (SAM) of $48 billion by 2027. The company supplies chips and software to the automobile sector. Its chips power sensor capabilities like LiDAR and Radar, and vehicle electrification.
The consensus analyst revenue estimate for FY 2022 is $110.73 million, representing a YoY growth of 129% and for FY 2023 it is $222.64 million, representing YoY growth of 101%.
The company’s revenue in Q3 2022 grew by 147% YoY to $30 million. The company’s margins have been expanding. The adjusted gross margin was 50.4% compared to 43% in Q3 2021.
Tom Schiller, CFO of the company, said in the earnings call, “To put this performance in better context, when we announced our plans to IPO in Q4 2020, indie was at just $6.7 million in quarterly revenue with a 35.4% gross margin. Since then, and despite global supply chain constraints, we successfully scaled our business nearly five-fold and increased our gross margin by 1,500 basis points in less than 24 months”. Net loss was ($37.6) million compared to ($79.6) million in the same period last year.
Co-founder and CEO Donald McClymont discussed a strong backlog when he said “We’re excited to announce that our strategic backlog has grown to $4.3 billion, more than doubling from the level we initially outlined during our IPO launch less than twenty-four months ago.”
Beth Kindig and the I/O Fund own TSM, Microsoft, and Enphase from the list of top ten stocks at the time of writing. I/O Fund has losses on Enphase, minimal gains on TSM and has owned Microsoft off/on for a few years. The stock disclosure is not intended to recommend a stock pick to Essentials, rather these disclosures are required to avoid any conflict of interest. These stocks are included in this list because they were notable performers last year. The I/O Fund trades stocks frequently and offers position updates on our official stock picks for Essentials Members only.