Artificial Intelligence (AI) has been a hot topic recently, and many companies have acted fast to release new products in the space. In light of this, I want to take the opportunity to discuss two of my favorite AI-related stocks; let's dive in.
1. CrowdStrike
CrowdStrike (CRWD, Financial) is a Gartner Magic quadrant leader in endpoint security. “Endpoints” basically refers to the devices at the edge of an IT network, from PCs to laptops and even cell phones. These devices are often the most vulnerable to attack from hackers, as that is where the user interacts.
There has been a lot of hype around the AI industry over the past year, but CrowdStrike has integrated AI into its application from day one. Its software works by first assessing the “security posture” of a user's device. This includes tracking various factors such as location, device, usage, etc. Then CrowdStrike looks for anomalies in the standard pattern in order to detect potential breaches. For example, let’s say a user normally accesses the internet and HR applications from Miami, Florida but then suddenly is accessing finance applications from Russia, this could be an indication of a state sponsored actor who has breached the system.CrowdStrike then cross checks any attack signature with its vast database, which is continuously improving, capturing trillions of events per day. Of course all this data is analyzed with AI, before being passed to a human oversight team in specific high risk scenarios.
In May 2023, CrowdStrike expanded its portfolio with new AI specific products such as Charlotte AI. Charlotte AI is basically like a co-pilot for a Chief Information Security Officer. This enables the individual to query the data and answer specific questions.
In addition, the company has forged a partnership with Amazon's (AMZN, Financial) AWS, leveraging its new Bedrock AI service.
Secure financials
CrowdStrike generated secure financial results for its first quarter of fiscal year 2024. Its revenue was $693 million, which increased by 42% year over year and surpassed analyst forecasts by $16.4 million. Its subscription model has resulted in highly predictable and fast growing revenue.
CrowdStrike operates with a “land and expand” strategy which involves cross selling customers to its various product modules. Customers which have adopted over five modules rose by a staggering 60% year over year. Its modules include cloud security, identity protection and observability, all vital parts of a security leader's tech stack. The idea is to offer a consolidated and scalable solution for ease of management and lower cost.
The Charlotte AI product also offers a huge upsell opportunity, as CISOs have an easy way to adopt AI and make their own lives easier.
In terms of margins, CrowdStrike reported a record high non-GAAP gross margin of 78%, which was driven by data center scale advantages.
The business did still generate a net loss of $19.5 million in the quarter, but this was better than the $23.9 million net loss generated in the equivalent quarter of the prior year.
This was driven by a stabilization of its non-GAAP operating expenses at ~61% of revenue, while its top line still continued to grow strong.
Sales cycles are elongating in the software industry, as buying committees delay spending and double check the ROI on any investments. The good news is CrowdStrike has a secure balance sheet to weather any economic storm with $2.93 billion in cash and short term investments reported compared to total debt of ~$794.4 million, which is manageable and well covered by the cash position.
Valuation
CrowdStrike trades at a price-sales ratio of 13.86, which is 56% cheaper than its five-year average.
The GF Value chart indicates a fair value of ~$372 per share and thus the stock is “significantly undervalued” at the time of writing.
2. Adobe
Adobe (ADBE, Financial) is a legacy software company which was founded way back in 1982. The business is well known for developing the popular PDF file format, which is used commonly throughout the world today.
The company also pioneered some of the world's most popular creative products such as Photoshop, Illustrator and Premiere Pro for video editing. According to Adobe, its products are used by “over 90%” of the world's creative professionals. These tools are also deeply embedded into the education system and commonly taught in a variety of classes.
The only negative for Adobe in my opinion is the business faces substantially more competition now than it has in recent years. It's been a while since the company has faced this kind of competition as it was meticulous about building its monopoly. For example, Australian company Canva was founded in 2012 and disrupted the industry with its “Freemium” go to market approach. This led to mass adoption by social media creators who wanted a cheap and easy to use tool to produce content at scale. Canva was ahead of the curve in this regard and in 2021 the business raised a further $200 million at a staggering $40 billion valuation. This is still a far cry from Adobe's ~$200 billion valuation, but the company is catching up.
Adobe has begun to integrate AI into various products, which could be a huge growth catalyst. Its most recent project is called “Adobe Firefly,” which is a plethora of generative AI modules which are integrated into Adobe's various software tools such as Photoshop. This enables a designer to execute simple prompts such as “change font size” as well as more advanced prompts such as “change the entire scene to winter from summer."
Adobe has also released an AI art generator and a tool called “Generative Fill." This enables a user to highlight a certain part of an image, let’s say a river, and then automatically generate realistic looking variations.
Adobe has also launched an AI podcast tool. This enables a user to upload an audio file, which can then have echo removed automatically.
Steady financials
Adobe reported steady financial results for the first quarter of the fiscal year 2023. Its revenue was $4.66 billion, which rose by ~9% year over year, or 13% on a constant currency basis.
Its Digital Media segment contributed to the vast majority (73%) of its revenue with $3.4 billion reported, rising by 14% year over year. This segment consists of the aforementioned Creative Cloud software.
Document Cloud reported a 13% year over year increase in revenue to $634 million. This was driven by its signature product “Acrobat Sign” which was a popular tool for SMBs and enterprises.
Adobe is immensely profitable and reported $6.1 billion in operating income for the first quarter of fiscal 2023. This rose by just 0.10% year over year, but a roughtly 34% margin is hard to complain about, given the average company in the software industry has a margin of 23%.
Adobe has a strong balance sheet with $5.6 billion in cash and cash equivalents compared to total debt of $4.1 billion, of which the vast majority ($3.6 billion) is long-term.
Valuation
Adobe trades at a price-sales ratio of 12.01, which is 22% cheaper than its five-year average.
The GF Value chart indicates a fair value of ~$666 per share and thus the stock is “significantly undervalued” at the time of writing.
Final thoughts
Both CrowdStrike and Adobe are fantastic software companies in my opinion. CrowdStrike is expected to benefit from the continued growth in the cybersecurity industry as companies aim to protect themselves from breaches, while Adobe is powering the creator economy and its new AI tools could be an enticing catalyst. Software companies tend to be highly scalable with exceptional long term margins, and these are two of my favorites.
