Creativity is one of my favorite attributes to consider when adding to an existing holding or looking for new investments. Whether it comes from innovative product ideas themselves or from thinking outside the box to find new revenue streams, companies focused on creativity often excel at generating long-term growth optionality.
This access to growth-driving business options has proven to be one of the most vital indicators of long-term success for companies in the stock market, showing an ability to innovate and adapt to an ever-changing and increasingly technological world.
Today we'll look at two of my favorite leaders in creativity and discuss why their inspiring products have them poised to beat the market.
Image source: Getty Images.
Adobe
Driven by its mission "to change the world through digital experiences," Adobe (ADBE 1.42%) is arguably one of the most creativity-inspiring stocks on the market. Operating through two segments, Digital Media and Digital Experience, Adobe and its software solutions are vital components of the creator economy.
However, despite its importance in the creative space, the company has seen its shares slide over 30% lower in just the last three months.
This decline came despite Adobe posting revenue growth of 20% year over year and generating nearly $2 billion in free cash flow for the fourth quarter. Thanks to this decline in share price and consistently growing free cash flow, Adobe has become quite affordable on a price to free cash flow basis.
ADBE Price to Free Cash Flow data by YCharts.
Now trading at just 31 times free cash flows, the company holds the most affordable valuation it has seen since 2019. More importantly, its operations look more robust than ever.
As of Q4, Digital Media and Digital Experience posted all-time highs for quarterly sales at $3 billion and $1 billion, respectively. Despite these record revenue figures, Adobe still faces a long-term growth story ahead in terms of its total addressable market (TAM) in each business line.
| Metric | Creative Cloud | Document Cloud | Experience Cloud |
|---|---|---|---|
| 2024 TAM estimate | $63 billion | $32 billion | $110 billion |
| 2021 Revenue | $9.5 billion | $2 billion | $3.9 billion |
| TAM/Revenue multiple | 7x | 16x | 28x |
Data from Adobe's Q4 Earnings Presentation -- TAM = Total Addressable Market.
Adobe's Digital Media segment, composed of the Creative and Document Cloud applications, offers seven and 16 times upside compared to their TAM sizes. Whether it's Creative Cloud's 3D and metaverse software through Substance or Document Cloud's 2.5 billion Adobe and Reader installations across all devices, the Digital Media unit has benefited the lives of many creators.
As stable as Digital Media's growth looks to be, Adobe's Experience Cloud offers the highest growth potential, with its 2024 TAM being 28 times larger than its current sales. Providing valuable growth optionality by focusing on anything related to customer experience, the Experience Cloud covers everything from analytics, customer engagement, and advertising campaigns to new customer targeting.
Currently accounting for roughly one-quarter of sales, Experience Cloud applications and services are some of the biggest brands in the marketing world and will allow Adobe to grow as these companies succeed.
Ultimately, Adobe's three unique business verticals of creative software, marketing platforms, and data management tools, plus its long-term growth optionality, make it a very enticing investment at just 31 times free cash flow, especially considering that free cash flow per share has grown by 24% annually over the last five years.
Unity Software
With more than 70% of the top 1,000 mobile games built using Unity Software (U 1.15%) and its creation engines, the company has quietly become the dominant player in an increasingly important niche. Through its aptly named Create Solutions and Operate Solutions segments, Unity enables content creators to build and monetize real-time 3D environments.
However, despite this leadership position in the mobile gaming space, Unity has much broader ambitions for its creative capabilities. Ranging from e-commerce to manufacturing, architecture, and entertainment, the company has seen its non-gaming operations take off, growing by 70% year over year versus overall sales growth of 43% for Q4.
Thanks to this growth, non-gaming sales account for 25% of Create Solutions' total revenue, and management has come to recognize a much larger TAM. For example, when Unity went public in 2020, it saw a $29 billion TAM for its Create and Operate segments combined.
Now, just a little over a year later, it estimates this TAM to be closer to $45 billion thanks to a bevy of new customers joining its non-gaming operations. An excellent example of Unity's potential in this area comes from its relationship with Hyundai Motors. By helping the auto giant build a digital twin of its factory, Unity will help Hyundai discover real-time insights from its manufacturing process and enable collaborative, interactive innovation over time.
U PS Ratio data by YCharts.
Trading at a price-to-sales ratio of 26, Unity is still far from being considered cheap even after seeing its shares cut in half recently. However, its market capitalization of $31 billion seems too small considering its domination in the mobile gaming industry and the massive optionality potential it holds outside of gaming.
Thanks to Unity's truly innovative core, I am confident in management's ability to create new solutions for its customers and to create new streams of revenue as time goes on, making this sell-off a welcome opportunity for me to add shares.
