Free cash flow (FCF) is the lifeblood of a business. Think of it this way; FCF is how much money you add to your bank account after subtracting bills or capital expenditures (like a car) from your monthly income. That extra cash gives you the power to invest, pay down debt, or perhaps start a new business. FCF is important for you and is just as vital for companies.
Two companies that produce loads of FCF yet are trading at a discount are Airbnb (ABNB 1.09%) and Adobe (ADBE -0.37%). Read on to find out why the market is discounting both stocks and how these two are intriguing investments right now.
1. Airbnb
Airbnb has become synonymous with alternative stay accommodations. When a company has become a verb or noun in everyday speech, then you know that the company has serious branding power. However, some investors are worried about some short-term headwinds with the platform.
First, many fear consumers will start tightening their wallets and eliminating trips. Clearly, this would affect Airbnb, but management wasn't seeing any signs of a slowdown in the third quarter. Nights and experiences booked rose 25%, and the fourth-quarter backlog was strong. While an outright recession would harm Airbnb, the odds of one happening are diminishing.
Second are those pesky cleaning fees. How often have you almost booked the perfect Airbnb until you saw the final price at the checkout screen? I know I have been appalled by some outrageous cleaning fees, but CEO and co-founder Brian Chesky is committed to fixing them. He noted that the feature was never intentionally designed, and now that it is being abused, Airbnb is cracking down on the practice. This fix should improve its brand among travelers, eventually eliminating another concern.
These fixes should help Airbnb stay at the top of the alternative stays hierarchy, allowing it to continue producing loads of FCF. In Q3, Airbnb generated $960 million in FCF, bringing its trailing 12-month total to $3.3 billion. That means Airbnb trades at 21 times FCF -- a cheap valuation for a stock growing its revenues at a 29% pace.
ABNB Free Cash Flow (Quarterly) data by YCharts.
Airbnb has some issues to fix, but it's still the top offering among its peers, and its FCF generation makes it an excellent investment.
2. Adobe
Adobe's product suite is the industry standard for digital design products. Its software is taught to high schoolers and college students, making it an obvious choice when this cohort eventually hits the workforce. Adobe has also been a phenomenal investment over the past five years, returning 100% compared to the S&P 500's 65%.
However, recent business decisions have shaken long-term investors' faith in management.
Back in September, Adobe announced it was acquiring collaborative design (and direct competitor) company Figma for $20 billion. The kicker? Adobe is paying about 50 times sales for it. That's an expensive valuation, and a questionable use of Adobe's cash, especially since it practically wipes out all of Adobe's share repurchases it made in the past five years. But, because Adobe is an FCF-generating machine, it can quickly digest this acquisition.
In Adobe's fiscal year 2022 (ending Nov. 30), it produced a record high of $7.4 billion in FCF. So, if it doesn't grow at all, it could digest the Figma acquisition in three years if it dedicated all of its cash flow to repurchasing shares it issued to fund the acquisition, pay off debt, and replenish its cash hoard. Furthermore, the no-growth assessment is faulty because Wall Street analysts think Adobe will grow its revenue by 9.3% and 11.9% in FY 2023 and FY 2024, respectively.
If Adobe can maintain its strong 42% FCF margin, it would produce $17.1 billion in FCF over the next two years, almost knocking out the acquisition in that same time frame.
Despite these numbers, many investors are only concerned about the short-term hit, causing them to head to the exits. This has given long-term investors an excellent entry opportunity, as Adobe is now valued at its lowest state since it switched business models in 2014.
ADBE Price to Free Cash Flow data by YCharts.
Adobe is an absolute bargain at these prices, and although the stock might see some significant price swings when (and if) the Figma acquisition goes through, the long-term trajectory for Adobe is still positive.
