Artificial intelligence (AI) is experiencing rapid growth, and its potential applications and impact are vast. As AI technology continues to evolve and mature, it is expected to play an increasingly important role in shaping the future of various industries and society as a whole. Adobe Inc. (ADBE, Financial) is one of the companies that is anticipated to benefit from this trend.
Adobe is a leading creative software company that has been integrating AI and machine learning (ML) technologies into its products to enhance the user experience and streamline creative workflows. It's also trying to nip any potential disruption in the bud. AI is very promising for productivity across business and society, and I believe Adobe is in a prime spot to benefit from the global expansion of AI. However, the stock's valuation seems to be a major problem for now.
How is Adobe using AI?
First, let's take a look at how Adobe is using AI to drive future growth prospects. Adobe has a suite of digital art and business solutions that can achieve marketing goals and creativity in projects, and its products actually streamline quite well with AI.
Adobe Sensei is an AI and ML platform that powers many of Adobe's products. It helps to automate time-consuming tasks and enables users to focus on the creative aspects of their work. For example, Sensei can automatically tag and organize images in Lightroom, or suggest edits to improve the quality of a photo in Photoshop.
Content-Aware Fill is a Photoshop feature that uses AI to intelligently fill in areas of an image when an object or person has been removed. The AI analyzes the surrounding pixels and creates a seamless blend between them, resulting in a more realistic-looking image.
Adobe Stock is a library of images, videos and graphics that can be licensed for use in creative projects. AI can help users find the content they need more quickly by analyzing search queries and suggesting relevant results.
Adobe XD is a design tool for creating user interfaces and experiences. It uses AI to suggest design elements and layouts based on user input, streamlining the design process.
Industry applications
One of the main drivers of Adobe's AI growth is its applications can be used in various industries, including health care, finance, manufacturing, transportation and entertainment. AI is being used to improve efficiency, accuracy and decision-making in these industries already. For example, in health care, AI is being used to diagnose diseases, predict patient outcomes and develop new drugs. In finance, AI is being used to detect fraud, make investment decisions and manage risk.
Another important factor contributing to the growth of AI is the availability of cloud computing services. Cloud computing makes it easier for businesses and organizations to access AI tools and infrastructure, without having to invest in expensive hardware and software. Adobe switched to a cloud model long ago.
In addition, the growth of AI is also being driven by advancements in natural language processing (NLP), computer vision and robotics. NLP is allowing machines to understand and interpret human language, while computer vision is enabling machines to recognize and interpret visual information. Robotics is allowing machines to interact with the physical world, performing tasks that were once reserved for humans. I see quite a long runway for Adobe to expand its products as AI becomes more complex. Imagine something like ChatGPT being integrated into Photoshop, or computer vision being integrated into certain Adobe products!
Financials and valuation
Adobe is a growth stock that investors like for its revenue trend. The company reported sales growth of 23.94%, 15.57%, 22.82% and 10.31% for fiscal years 2019, 2020, 2021 and 2022, respectively. Although the slowdown in growth for 2022 seems worrisome, turning to quarterly revenue trend analysis, things seem pretty good for Adobe. The balance sheet is strong with a debt-to-equity ratio of 0.29 and a current ratio of 1.12.
The two key reasons for concern are profitability and valuation. It is very positive that Adobe has a strong free cash flow trend, but the net margin has declined by 12% year over year and the operating margin has declined by 8%.
I also argue that the valuation is rich now. The stock has a price-earnings ratio of 36.52 and a price-sales ratio of 9.47. Comparing these numbers to the Information Technology sector medians, Adobe is expensive.
Looking at the forward valuation numbers, Adobe has a forward price-earnings ratio of 32.61, a forward price-sales ratio of 8.63 and a forward price-to-free-cash-flow ratio of 20.17 based on my estimates, though Morningstar (MORN) is more generious and gives it a forward price-earnings ratio of 24.41.
Overall, I see Adobe as a high quality company that is profitable and growing, and it is expected to benefit from its business applications growing with the help of AI. It's on the watchlist, though I think it's too expensive for now.
