If the investment theme for 2021 was the post-COVID rebound, and the theme for 2022 was bracing for inflation, think of 2023 as the year investors should buckle up for a downturn. “Certainly the odds have increased that we’re heading into a recession,” says Ramiz Chelat, a portfolio manager for Vontobel’s Quality Growth Boutique. In fact, a whopping 98% of CEOs polled in a recent survey by the Conference Board said they were preparing for a recession in the U.S. in the next year.
The engine driving those recession fears, ultimately, is inflation—which in turn has launched the Federal Reserve on a campaign of interest rate hikes that has threatened corporate profits and helped drive the stock markets into bear territory over the past year. There are glimmers of hope that inflation may finally be peaking, but the watchword for 2023 remains caution.
Still, where regular investors may just see pain, investing pros see opportunity. Investing in 2023 is “really about quality,” says Lori Keith, director of research and portfolio manager at Parnassus Investments—in other words, owning companies “that not only can weather a deeper, more prolonged recession, should we see that, but also [are] able to participate when we do finally see a reversal” of the Fed’s rising-rate strategy.
Spotting those quality stocks may involve a change in mindset, for amateurs and pros alike. Eric Schoenstein, a managing director and portfolio manager at Jensen Investment Management, says he’s been tweaking his thinking when evaluating stocks, focusing more on profit margins than revenue growth. With war in Ukraine and persistently high inflation, and likely more rate hikes ahead, “I don’t think this is an environment where top-line growth is as easy to achieve, [and] that’s going to be with us for a period of time,” he says.
With that backdrop in mind, Fortune asked five top portfolio managers for their best stock picks for 2023. The stocks run the gamut from defensive staples to bets on emerging markets. But many of the companies listed here have a few superpowers in common that should help them navigate the coming year, including business models that generate lots of recurring revenue; strong balance sheets; and pricing power that should help them pass rising costs through to customers without severely denting their profits. You won’t find as many tech companies in the bunch: Their near-term prospects tend to suffer when interest rates are high. Still, the companies here should provide stable growth and profit margins as investors prepare for—deep breath—a new year, and wait for an eventual rebound.
“Sticky” services, steady earnings
If a recession is in the cards for 2023, money managers believe that businesses with “sticky” products and services—offerings that tend to generate and retain customer loyalty—will deliver steady revenue streams and perform well for investors.
A favorite of Keith’s for years, Republic Services is the second-largest waste management company in the U.S. Keith argues that in rough times it “provides that degree of defensiveness,” given its market share. She also notes that the company has a “very significant amount of recurring, annuity-type revenue”: In fact, about 80% of its revenue comes from such recurring sources, through services that are “mission critical” to commercial and residential customers alike. Republic has a nearly 95% customer retention rate, and its contracts—which often span multiple years—include inflation escalators that allow the company to increase prices as it deals with higher costs. Keith also applauds the company’s capital-allocation strategy and highlights acquisitions, like its recent purchase of US Ecology, another waste management firm. Trading at around 28 times its estimated earnings for the next 12 months, the stock isn’t necessarily cheap. But analysts project that Republic can grow earnings by over 10% in 2023—a decent clip in a slower growth environment. And the company should be more insulated in a short-term recession, Keith notes, since many of its contracts are of longer duration and can’t be modified.
Otis Worldwide is an elevator equipment manufacturer that, though not in “exactly a super glamorous industry,” is what Keith considers a “very good business in terms of being able to generate consistent profits and cash flow.” Otis is the leading firm in the elevator industry worldwide, with over $14 billion in revenue in 2021, and its business is split between new equipment sales and servicing and upgrades of existing elevators. There are a lot of aging elevator systems that need to be replaced in commercial buildings, Keith notes, so there’s a “nice replacement cycle in front of us.” Service and maintenance, meanwhile, provide recurring revenue for Otis and make its earnings more predictable. While the company has been hurt by commodity costs and unfavorable exchange rates driven by the strong dollar, Keith believes it can keep steadily growing earnings. Otis also doles out a nearly 1.5% dividend yield, and year to date has repurchased $700 million worth in shares. Although revenues aren’t expected to go gangbusters in 2023, the Street expects Otis to increase earnings per share by a hefty 12% next year. Its shares trade at around 24 times estimated forward earnings, and Keith believes investors can take a ride—hopefully, upward—on this “very wide-moat business.”
Seeking steadiness doesn’t require sacrificing growth. Jensen’s Schoenstein still believes Microsoft, which was also featured on our stocks to buy for 2022 list, could provide investors with both. “Because it’s commercially focused, it’s not so much about the economy growing for them as it is about their business customers continuing to need their services,” Schoenstein points out. “Unless you have large-scale business failures, Microsoft’s services are still going to be in pretty strong demand.” That includes the tech titan’s enterprise office and productivity software as well as its powerhouse cloud unit; those offerings “are actually allowing companies to be more efficient, which helps them in recessionary times,” he notes. Microsoft ended its 2022 fiscal year in June with just shy of $200 billion in revenue, and analysts project it can grow revenues by about 7% in the fiscal year ending June 2023, and 14% the following fiscal year. That would be below the company’s average of around 15% or so in the past five years, but it still represents a decent pace, given the lackluster economic backdrop. With its shares trading at about 25 times forward earnings, Microsoft also doesn’t come nearly as expensive as some of its growthy tech peers.
Parnassus’s Keith believes that Sysco also fits into the “recession-proof bucket.” Sysco is the world’s largest food distributor, servicing the likes of restaurants, hotels, and hospitals. Keith notes that the company has benefited from having “very significant market share” in the U.S., at about 17% of the fragmented field. That leadership position helps the company on many fronts: “Sysco is investing in their business in terms of technology, in terms of their employees, [and] having the ability to service customers more efficiently,” Keith says, which should help them gain even more market share. She also points to the firm’s track record for surviving downturns well, noting that it navigated the 2008 financial crisis deftly: “There’s a really strong case here that the company can weather additional downturns.” Although recessions often prompt consumers to spend less money at restaurants, Keith notes that owing to changes in demographics and spending habits, consumers will likely continue eating out if the economy slumps in 2023. And if inflation does begin to meaningfully cool next year, that should also help Sysco by lowering its costs for fuel and other expenses. Analysts expect the company to post a whopping 53% earnings per share growth in the fiscal year ending June 2023; the stock trades at a reasonable 20 times the next 12 months’ earnings, with a 2.3% dividend yield.
Classic recession stocks
In difficult times, it can be comforting—and prudent—to return to what you know. And some money managers suggest doing just that, recommending stocks in industries that historically hold up well in recessions and lower-growth environments.
TJX, the off-price retailing giant whose stores include T.J. Maxx and Marshalls, is a longtime favorite of Eric Schoenstein’s. TJX falls into the category of what Schoenstein calls “treasure hunt” stores, where budget-conscious customers search for deals. He points out that there’s a “good track record of strong consumer trade-down spending in recessionary periods,” which should be a boon for TJX if 2023 is as glum as some CEOs fear. The company buys some of its inventory from full-price department stores that can’t sell it—and Schoenstein believes that if there is a recession, TJX should be able to get more of that discounted overstock. Morningstar analyst Zain Akbari is of the same mind, writing in a recent note that “with consumers increasingly looking for value amid an unsettled economic landscape, we believe TJX is well positioned.” The Street expects TJX to increase earnings per share by about 11% next year and to almost double that in 2024. The stock trades at 23 times forward earnings and comes with a 1.5% dividend yield.
For investors who are really wringing their hands about the possibility of a 2023 recession, Schoenstein recommends tried-and-true Procter & Gamble, what he considers “your classic consumer staple that ought to be pretty good during a recession.” The consumer goods titan’s business focuses on “personal care, grooming, home care, fabric care, baby care,” he notes. “People don’t stop spending on those things.” And even if tougher times and sticky inflation prompt consumers to look for the cheaper brand on the shelf, Schoenstein says, P&G has some lower-price brands within its family of products.
As a large holding in the S&P 500 (it has a market cap of well over $300 billion), P&G has been hit by the overall selloff in the market; its share price has declined over 13% so far this year, as has the benchmark index. But Schoenstein says the company is still “showing strong, resilient, organic revenue growth”; from his perspective, that’s an upside that offsets hits to P&G’s business that have been driven by currency issues, with the U.S. dollar having soared compared with other global currencies. Both earnings and revenue growth are expected to be muted next year, but Schoenstein highlights P&G’s 2.5% dividend yield as something that strengthens its case for investors. If the company posts the anticipated growth, he says, it “will have a better opportunity to stand out in investors’ minds as everything else slows.”
James Tierney, chief investment officer of concentrated U.S. growth at AllianceBernstein, favors Zoetis, which makes medicines and vaccines for pets and livestock. “Animal health is going to be something that you need year in, year out, whether you have a recession or not,” Tierney notes. The stock has encountered some headwinds, including exchange rate issues, since a sizable portion of its business is outside the U.S.; supply constraints; and a shortage of veterinarians working in clinics. These factors have prompted Zoetis to lower sales guidance for the year, and its stock is down nearly 40% in 2022. But Tierney says the company’s balance sheet is “ironclad,” and believes that issues like vet supply will correct themselves next year. CEO Kristin Peck said on Zoetis’s recent earnings call that she’s optimistic the firm has the drug pipeline, market dominance, and financial fortitude to “continue outpacing” growth in the animal health market. Zoetis is expected to bring in nearly $8 billion in revenue this year, and analysts estimate the company can grow earnings by over 8% in 2023, while revenues could grow more than 6%.
Recession or not, if your car needs to be fixed, you’re going to fix it. That’s why Parnassus’s Keith likes O’Reilly Automotive, the auto-parts retailer. In tougher economic times, Keith notes, “drivers hold on to their cars for longer [and] look to do more repairs versus purchasing new cars,” a trend that should benefit O’Reilly. She applauds the company’s strong cash flow generation and sturdy balance sheet, and says it has typically performed well in recessions. On the back of a strong third-quarter earnings report, during which the company beat estimates and raised earnings guidance for the full year, analysts across Wall Street upped their price target for O’Reilly. And the Street estimates the company can grow earnings per share by over 12% next year, a hearty clip faster than the 6% they expect for 2022. O’Reilly’s stock, meanwhile, is expected to trade around 23 times forward earnings in the coming year.
Ramiz Chelat of Vontobel says investors may be surprised to find that some emerging markets will be “quite resilient” in 2023—in particular India and Brazil, whose economies could outperform markets like the U.S. heading into next year while at the same time having room to cut interest rates. Factors like these, in those and other countries, could make emerging-market growth look more appealing than developed-market growth in certain areas next year, Chelat argues.
For those reasons among others, Chelat likes Heineken, the globally known brewer based in the Netherlands. Chelat says the company has a strong presence in Brazil and Southeast Asia, “which are seeing improving growth” as they accelerate their post-COVID pandemic reopening. He believes those markets structurally “should be in better shape in 2023 and beyond” than the U.S. Chelat notes that despite weaker earnings in the most recent quarter, Heineken has maintained strong pricing power, while generating organic volume growth in the upper single digits. Analysts estimate that Heineken can grow revenue in the 8% range and earnings per share by about 7% for the next calendar year. In 2023, the stock is expected to trade at a reasonable 17 times forward earnings (it’s currently trading at around 14).
Chelat is particularly bullish on India in the wake of systemic reforms of the country’s tax and bankruptcy laws. India’s GDP is estimated to grow at around 5% next year, a rate which, while slower than in 2022, will likely outpace that of the U.S. and many other countries. Chelat argues that India is a market that’s poised for growth in mortgages and consumer credit. That belief is reflected in his enthusiasm for HDFC Bank, a longtime holding of Vontobel’s, which he says is still “taking market share in its core segments, in mortgages in particular.” That business is only expected to get stronger as the company completes its merger with one of India’s leading housing finance firms. Chelat says the combined network will be able “to sell mortgages across a much wider branch network and leverage HDFC Bank’s deposit strength.” Analysts are optimistic, predicting nearly 21% revenue growth for the fiscal year ending in March 2024 (for the current fiscal year, ending next March, analysts estimate it will bring in over $14 billion in revenue), while earnings per share could grow roughly 17% in the same time frame. Trading at around 19 times the next 12 months’ estimated earnings, HDFC’s stock is among the cheaper picks on Fortune’s list—a potentially nice entry point for investors willing to bet on emerging markets.
For those who have faith in consumer demand in Southeast Asia, AllianceBernstein’s co-CIO of concentrated global growth Dev Chakrabarti recommends Philippines-based Universal Robina. It’s a consumer staples company that makes snacks, cup noodles, and beverages, exporting its wares to countries like Indonesia and Vietnam; it brought in $2.4 billion in revenue in 2021. Chakrabarti believes that Southeast Asian markets are seeing the benefit of manufacturing moving outside of China; he expects that a growing youth demographic and rising incomes will combine to “be a key driver of demand for branded consumer goods.” That should all benefit Universal Robina, which Chakrabarti says has taken advantage of the pandemic’s disruptions to improve its costs, poising the company to profit from Asia’s post-COVID reopening. Though higher costs have put pressure on the company’s margins, it recently reported strong sales growth in its third quarter, and Chakrabarti expects it will be able to push through price increases to offset inflation. Analysts expect Universal Robina’s earnings to shrink this year, but they estimate the company can deliver over 15% earnings growth in 2023 while growing revenues at around 7%. The stock, meanwhile, comes historically cheap: It’s trading 30% below its five-year high as well as below its average price-to-earnings ratio for that period. J.P. Morgan analysts consider the stock an “underappreciated high-quality staples name.” That could offer investors an inexpensive way to bet on the Southeast Asian consumer.
Picks from the experts
Republic Services (RSG, $134)
Otis Worldwide (OTIS, $78)
Microsoft (MSFT, $241)
Sysco (SYY, $85)
TJX (TJX, $78)
Procter & Gamble (PG, $143)
Zoetis (ZTS, $146)
O’Reilly Automotive (ORLY, $838)
Heineken (OTC:HEINY, $45)
HDFC Bank (HDB, $68)
Universal Robina (PSE:URC, $2)
Prices as of 11/18/22
How Fortune did
To quote a colleague: Oof. We believed our “Stocks for Smoother Sailing” for 2022 would withstand inflation. But prices and interest rates rose far faster than we expected, and our picks lost a median of 41% over the past 12 months. Here’s how it went down.—Matt Heimer
Big Tech, tamed
Tech giants are hardly teetering on the verge of extinction. But the growth they saw in the COVID work-and-shop-from-home lockdown era wasn’t sustainable—nor, it turns out, were the share valuations that our picks Microsoft, Amazon, and Salesforce were commanding a year ago. They racked up losses of 29%, 49%, and 51%, respectively.
Few companies dominate their industry like chipmaker Taiwan Semiconductor Manufacturing Co., and in the five years through January 2022, its stock nearly quintupled. This year, the combination of geopolitical tensions and recession fears dimmed its luster; its shareholders lost 32% over the past year, while the S&P 500 lost just 14%.
Our portfolio’s only outperformers were consumer staples stocks, which often do well when recession fears loom. Those included Nestlé, Johnson & Johnson, and—speaking of chipmakers—PepsiCo, owner of Frito-Lay. Pepsi was our best pick, with a 14% total return; for more on the beverage and snack giant, see our feature in this issue.
A version of this article appears in the December 2022/January 2023 issue of Fortune with the headline, “11 stocks to stick with for 2023: Bullish prospects in bearish times.” Parts of this article were previously published online on Oct. 13, 2022, under the title, “Where to invest now: The 8 best stocks to buy for 2023.”