The software sector is full of stocks that can generate fantastic returns. Profitability in this niche is much higher than in other industries, and the shift toward a subscription-based selling model makes sales trends for these companies more predictable as well.
With those attractive factors in mind, let's look at two standout stocks that dominate their respective software markets. Read on for some good reasons to buy Microsoft (MSFT 0.73%) and Adobe (ADBE 1.53%) right now.
1. Microsoft has enviable financial strength
It's not hard to see why Microsoft's stock is beating the market so far in 2023. Sure, in late January, the software giant announced slowing sales growth. Revenue ticked up by just 2% through late 2022. But the company still logged $53 billion of revenue in that fiscal second-quarter period.
Microsoft's cloud revenue soared a blistering 29% year over year in Q2 after accounting for currency exchange swings. Gains there and in areas like cybersecurity helped offset weakness in segments like PC software and video games. Tech investors would normally need to purchase several stocks to find that level of diversification.
The company's earnings power is an even bigger draw. Microsoft generated $20.4 billion of operating income last quarter, translating into a nearly 40% operating margin. Shareholders can count on that market-beating profitability to continue into 2023 even if a recession strikes the wider tech world.
2. Adobe's cash flow is on an upward trajectory
Investors who appreciate cash will find many reasons to like Adobe stock this year. Growth is slowing in 2023, with revenue rising by 13% year over year in the most recent quarter after accounting for currency swings. Investors had seen growth rates of closer to 20% in earlier phases of the pandemic.
Adobe's scale allows it to generate excellent profits even in a slower-momentum period. Operating income is over 30% of sales today and operating cash flow last quarter was $1.7 billion, or roughly 36% of sales. "Our strong engine of innovation combined with world-class operational rigor drove profitable growth in Q1," CFO Dan Durn told investors in mid-March.
ADBE Cash from Operations (TTM) data by YCharts
Most analysts are expecting Adobe to increase sales by 10% this fiscal year. But the long-term outlook is even brighter as more media and work processes move into the digital realm. The company leads in these important tech niches which are highly likely to expand over time following the current slowdown.
Investors don't have to pay a huge premium for exposure to that business, either. Adobe is priced at 9.4 times sales today, or near its lowest valuation in the past five years. It's possible that a recession in the tech industry would drive that valuation lower. But there's a good chance that shares will be setting new highs several years from now.
The software industry isn't immune to the weaker growth factors driving markets lower today. That's why it makes sense for investors to focus on highly profitable, diverse businesses in order to minimize risk. Adding Microsoft and Adobe to your portfolio accomplishes that goal while giving you exposure to growth niches like enterprise cloud services, digital media, and artificial intelligence. Consider putting these attractive software stocks on your watch list for 2023.
