There is a lot of excitement around Adobe (ADBE 1.53%) stock right now. The software specialist is trouncing the market in 2023 and its returns are topping other successful tech giants, including Microsoft (MSFT 0.73%).
Some of that rally can be pinned on the broader market surge that's sent the Nasdaq Composite index higher by 26% through late September. But Adobe is also having a great sales year. Its growth potential seems strong, too, even as the company targets higher profits ahead.
Here are three green flags pointing toward further growth for Adobe going forward.
1. The draw of artificial intelligence (AI) will benefit Adobe
In mid-September, Adobe reported a 13% quarterly sales increase year over year after adjusting for currency exchange rate swings. The resulting $4.9 billion of quarterly revenue easily beat management's short-term forecast range of between $4.83 billion and $4.87 billion.
Adobe executives proceeded to forecast another strong quarter ahead as revenue should cross $5 billion in the fiscal Q4 period (ended Dec. 1). "Our innovation engine, global reach and strong operational rigor position us to capture the massive opportunities ahead," CFO Dan Durn said in a press release.
A big part of that opportunity involves generative AI, which is rapidly being woven into many of Adobe's products. Its Firefly solution showcases many ways that users can harness the power of AI to improve photos and other digital media. People are loving the product, as over 2 billion images have been generated in just the last six months since Firefly was released.
2. Adobe is seeing rising margins
Growth alone isn't enough to support a bullish thesis for a stock. Luckily, Adobe delivers on the financial front as well.
Gross profit landed at $12.6 billion over the last nine months, or 88% of sales. Compare that result to Microsoft's 69% margin rate. Adobe's operating profit margin isn't quite as impressive as the software giant's, but profitability has room to expand toward that 40% level as prices rise and users gain more value from the platform.
Net income over the last three quarters was $4 billion, up from $3.6 billion a year earlier. There's no danger of a cash crunch approaching, either. Adobe is sitting on nearly $8 billion of cash today.
3. Cash flow is destiny for Adobe
Cash flow is arguably the most encouraging metric for investors today. Adobe is a software-as-a-service specialist, after all, so it books revenue over time thanks to subscription income.
ADBE Free Cash Flow data by YCharts
Operating cash flow was $2 billion this past quarter, or a blazing 38% of sales. This success came despite heavy investments into the platform, particularly in building out an early lead in generative AI for photos, documents, and video.
A strong company means a high stock valuation
The biggest risk for investors, then, is in paying too high a price for this profitable enterprise. That challenge isn't something to ignore. Adobe is valued at nearly 13 times sales as of this writing. You could own Microsoft for 11 times revenue, for context.
Adobe's business isn't as diverse as Microsoft's, which also includes exposure to any approaching AI boom. But it still maintains a large global sales base and a wide portfolio of services across digital media and enterprise cloud services. Investors worried about the stock's high valuation might want to watch Adobe in case a discount arrives with the next market pullback. But the stock is still likely to perform well over the long term, given its many avenues for more profitable growth ahead.
