3 Things Smart Investors Know About Adobe

Adobe (ADBE 2.16%) shares have delivered market-thumping returns in recent months. Wall Street is excited about the digital content giant’s brightening growth prospects. The business is unusually efficient at generating cash, too. Balanced against those positives is the fact that shares could be valued too high for new investors to see solid returns from here.

With that big picture in mind, let’s take a look at three standout factors for smart investors to know about this high-performing stock.

1. Innovation around AI is critical for Adobe

Innovation is a key competency for any software business, but it matters even more for Adobe, given its focus on digital creativity and workflows. That means lots of resources are directed toward research and development and continuously improving its cloud and digital media platforms.

Adobe is currently focused on incorporating generative artificial intelligence (AI) technology throughout its software. It’s a perfect fit for the company since its customers are interested in creating digital experiences. That’s a key reason why investors are excited about the stock, too; AI has the potential to rapidly boost the value of many software services.

“We believe generative AI will drive both further accessibility and adoption of our products,” CEO Shantanu Narayen told investors in mid-June.

2. Cash is king at Adobe

Adobe has a software-as-a-service selling model, with recurring revenue making up a large portion of its business. That approach tends to boost cash flow, which is excellent in this business.

Adobe generated $1.3 billion of net income last quarter, in fact, translating into a solid 27% profit margin. But it also produced $2.1 billion of operating cash flow, converting 44% of revenue into cash.

Wins here give management plenty of resources to direct toward innovation and marketing. They have also allowed Adobe to amass nearly $7 billion of cash on the books. “We deliver the innovation and the top line progression, but we do it in a very disciplined way, which drives margin and cash flow for investors,” CFO Daniel Durn recently told shareholders.

3. Adobe’s future is bright

Adobe executives see a long runway for growth ahead as more business and creative pursuits shift to digital mediums. Interest is especially high today around its recent generation of AI products called Firefly.

Broader success at attracting new business convinced management to modestly boost its 2023 outlook on both the top and bottom lines, helping push shares higher in 2023. It wasn’t all good news in this recent report, though.

Adobe said some enterprise clients are slowing their IT spending rates or taking more time to commit to contracts. Some investors might also see the stock as too expensive, given that sales are on pace to rise by only about 10% this year. Microsoft is growing slightly faster and is more profitable, yet Adobe shares are priced at a premium to the tech titan’s stock.

That premium doesn’t mean you can’t achieve market-beating returns from owning Adobe stock. But it does raise the risk that you’ll overpay for this attractive business. If your time horizon is long enough, though, the stock will likely be a positive force in a diversified portfolio.

Demitri Kalogeropoulos has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Adobe and Microsoft. The Motley Fool recommends the following options: long January 2024 $420 calls on Adobe and short January 2024 $430 calls on Adobe. The Motley Fool has a disclosure policy.

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