Adobe (ADBE) stock has hit all-time highs after quarterly results proved the wisdom of its shift to a cloud-based subscription business model — but the downside of that is ADBE has become too pricey for new money to benefit from the company’s successful change of course.
Indeed, the market has been optimistic about Adobe stock ever since it announced that it would rely more on subscriptions for its products and less on selling the software outright. Although it was seen as a high-risk move when Adobe unveiled the strategy a little more than a year ago, ADBE stock never really looked back.
Click to Enlarge Adobe stock is up nearly 70% during the past 52 weeks, beating the S&P 500 by more than 50 percentage points. Rather than slap a lower multiple on ADBE stock to discount for the risk associated with the strategic shift, the market just went bonkers on the course change – even as Adobe posted a string of declining profits.
Now, with the latest earnings report, ADBE put an end to a long period of year-over-year declines in both earnings and revenue, essentially proving that the bulls were right all along.
But with the valuation so stretched on Adobe stock, it doesn’t look like a good time to start a position.
Heck, the way ADBE stock has been running in anticipation of an earnings report like the one it just delivered, it wouldn’t have been too surprising if it had sold off on the news.
Adobe Stock – Great Run Makes Shares Too Pricey for New Positions
For the most recent period, Adobe posted its first rise in quarterly earnings in seven quarters. (Wall Street was projecting yet another decrease.) Revenue rose year-over-year for the first time in five quarters.
The key to success was better-than-expected growth in subscriptions to Adobe’s Creative Cloud Web software, which added 464,000 customers for a total of 2.31 million.
That helped revenue rise 5.7% to $1.07 billion, leading to a better-than-expected bottom line. On an adjusted basis, earnings came to 37 cents a share, well ahead of analysts’ forecast of 30 cents.
The shift to cloud-based subscriptions from one-time software purchases is going well — and that’s great for anyone holding Adobe stock — but it’s not exactly providing an attractive entry point for new money looking to stick around for a while.
Sure, ADBE stock could have more room to run as a trade, but as an investment of, say, three to five years or more, Adobe stock looks far too expensive.
ADBE stock now trades at 33 times forward earnings and 130 times trailing earnings. Valuation always reverts to the mean eventually, especially when stocks turn broadly south. With the bull market getting rather long in the tooth, this is not the time to initiate a position in anything with that kind of crazy-high valuation.
After all, the forward price-to-earnings multiple makes Adobe stock more than twice as expensive as the broader market, but its long-term growth forecast is only about 25% higher.
In other words, the successful shift to the cloud is already baked into Adobe stock — and then some.
If ADBE stock takes a good whacking to make the multiple more reasonable, by all means, buy on that dip.
For now, though, new money should only admire shares from afar.
As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.