With Adobe (ADBE +0.63%) shares up over 60% so far this year, it's understandable if investors feel like they've missed the boat on this stock. The rally has pushed its market capitalization above $250 billion -- a hidden gem this is not.
Yet you can still enjoy market-thumping returns by patiently buying and holding established tech businesses as they build on their market share leads. Apple stock has trounced the market over the past five years, for example, even after starting with a $1 trillion market cap in mid-2018. But is Adobe a strong enough business to generate meaningful returns from here?
Delivering more value
Adobe's sales trends have been positive recently but far from explosive. Revenue was up 13% in its most recent fiscal quarter after adjusting for currency swings. By comparison, Microsoft grew its larger sales base 10% .
NASDAQ: ADBE
Key Data Points
Still, Wall Street is excited about Adobe's potential, especially as artificial intelligence (AI) spreads through its platform. Generative AI has been overhyped in many parts of the market, but in Adobe's case, it makes sense to be optimistic.
The technology is already boosting the value of core software products like Photoshop by making picture and video editing easier. It's also unlocking new use cases for Adobe's applications and sparking interest in fresh offerings like Firefly. While investors should always tread carefully around the projected impact of much-hyped technology, there's a clear bull case for Adobe's platform delivering more value to creators over the next few years.
Cash flow is destiny
Adobe is no slouch when it comes to earnings power. Operating income through the first three quarters of fiscal 2023 was $4.9 billion, or 34% of sales. Cash flow is another critical financial metric for the company, and operating cash flow was a fantastic $1.9 billion last quarter, translating into 38% of sales.
Data by YCharts.
This cash flow is an excellent sign for investors for several reasons beyond implying faster earnings growth ahead. The cash helps fund stock buybacks plus robust investment in R&D and marketing. It could also lead to an eventual dividend down the line. In other words, it's a big factor supporting Adobe's ability to continue delivering solid returns for investors from here.
The price
Adobe's valuation could be a limiting factor, though. Shares are priced at nearly 13 times sales, up from 9 times sales earlier this year. That's higher than a wide range of successful software platform providers, including Shopify, Microsoft, and Palo Alto Networks, the cybersecurity specialist.
To earn that valuation, Adobe will need to accelerate its growth beyond a low double-digit rate while pushing profit margins higher. Wall Street is betting that this is possible over the next few quarters, but the safer bet is for these gains to arrive over several years.
As a result, new shareholders might be disappointed if they're looking for quick returns from this stock. If you're willing to be patient and focus on the long term, though, there's a good chance Adobe can outperform, even from today's elevated price.
