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An Overlooked Way to Play the AI Revolution

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As I’m sure you’ve heard, there’s a powerful new technology that’s quickly transforming the global landscape: artificial intelligence, or AI.

Over the past year, AI has rocked multiple sectors as businesses have embraced its vast potential. In fact, corporate executives mentioned this disruptive innovation over 30,000 times on 2023 earnings calls.

AI is already proving to be the most important tech breakthrough of the 21st century, transforming finance, healthcare, manufacturing and so on. No sector will remain untouched.

That’s why Tesla’s Elon Musk calls it “the most disruptive technology ever,” suggesting it could enable “an age of abundance.” Experts forecast AI could single-handedly boost global GDP by nearly $16 trillion in the decade ahead.

That would make it the greatest wealth creator in history.

Unsurprisingly, smart investors want exposure to this trend, which is why AI stocks have been on fire lately. So this week, we’ll take a look at an overlooked way to play the AI boom: software giant Adobe (Nasdaq: ADBE).

Adobe is primarily known for its creative and digital media software like Photoshop and Acrobat. But what many people don’t know is that the company has been integrating AI across its offerings through Adobe Sensei, its AI and machine learning platform.

Adobe also recently launched Adobe Firefly, a new family of creative generative AI models for generating images and text. Firefly leverages assets in Adobe Stock – the company’s collection of over 200 million images and graphics – to ensure commercially safe, on-brand content generation that helps boost productivity.

Adobe’s business is booming thanks to the continued adoption of AI.

Revenues have steadily risen 16.5% annually and are expected to grow another 10.7% this year. Likewise, EBITDA (earnings before interest, taxes, depreciation and amortization) has climbed 19.1% per year and is projected to increase by 31.6% in 2024.

Chart: Adobe's Business Is Taking Off

Free cash flow generation has been rock-solid, too. It’s risen by 13% per year over the past five years and is expected to grow by up to 25.2% this year.

Chart:

Now, as I noted recently, I’m upgrading some components of The Value Meter.

A metric I’ve been looking at more closely in recent years is enterprise value. It’s an alternative to market cap that better reflects the total cost of acquiring a company, not just the total value of its shares.

Net asset value, which is simply a company’s total assets minus its total liabilities, is another key measure I’ll be looking at. I’ll also consider companies’ cash flow generation.

By putting these factors together, the updated system underlying The Value Meter ranks companies based on more than just their price-to-sales (P/S) or price-to-earnings (P/E) ratios. It focuses instead on their acquisition cost relative to their net assets and their ability to produce positive cash flows.

The higher a stock’s ranking, the more undervalued it’s likely to be. And Adobe’s rank falls within one standard deviation of the mean among the over 3,600 stocks my system has scanned. In fact, it’s one of the most well-priced AI stocks out there.

The ratio of its enterprise value to its net assets, or its EV/NAV ratio, is around 15. That’s about 2 1/2 times higher than the average for all the stocks that were screened that have positive net assets. (Companies with a negative net asset value post a negative EV/NAV ratio, so they were excluded from the average.)

But that higher relative acquisition cost seems warranted.

Since the average company generates negative free cash flow, Adobe is already looking stronger financially than most stocks out there. Plus, on average, its free cash flow was 46% of its net assets over the past two quarters, compared with an average of 26% among companies that have positive cash flows and net assets.

In other words, Adobe generates almost twice as much free cash flow as the average company relative to its net assets. So the stock seems attractively priced.

With AI-enhanced offerings driving huge earnings and free cash flow growth in the years ahead, the stock looks well worth its current market price.

The Value Meter rates shares of Adobe as being “Appropriately Valued.”

The Value Meter

As always, if you have a stock that you’d like to have rated by The Value Meter, leave the ticker symbol in the comments section below.

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