Adobe Systems Incorporated Will Head Higher — Much Higher

ADBE stock is in the middle of a secular bull run

By Luke Lango, InvestorPlace Contributor

Its a red day for the market, but one stock bucking that trend is Adobe Systems Incorporated (NASDAQ:ADBE). The one-stop shop for creative professionals delivered preliminary fiscal 2018 guidance that was well above analyst estimates. Management expects earnings per share to be about $5.50, nearly 6% above where the Street was sitting ($5.20). The strong guide has ABDE stock up almost 12% on Thursday.

You'll Have to Weather the Chop to Get the Pop in ADBE
Source: Shutterstock

While I’m not one to usually chase rallies, I think ADBE stock is in the middle of a secular bull run. As the company has successfully transitioned to a cloud and subscription service-based business model, ADBE stock has taken off. It has climbed from $34 about five years ago to nearly $170 today, and the trajectory has looked like a straight-line with mitigated volatility.

It has climbed from $34 about five years ago to nearly $170 today, and the trajectory has looked like a straight line with mitigated volatility.

Why? Because Adobe is the king of its space and has very little formidable competition. With ADBE stock, then, you get all the rewards of secular cloud growth and high-margin and predictable recurring revenue streams, but none of the competitive risks that could unnaturally slow revenue growth or chip away at margins.

It’s a big reward, small risk narrative.

Investors will keep buying that narrative up. ABDE stock can and will head higher into the foreseeable future.

Adobe Is On Fire

Whereas many of yesterday’s tech giants have struggled in today’s dynamic marketplace, Adobe has flourished.

The company has proven itself to be exceptionally nimble and dynamic as the demands of its end-consumers have changed over time. The company has successfully migrated to a cloud and subscription service-based business model that has three big pillars: Creative Cloud, Document Cloud and Experience Cloud.

All three of these businesses are booming.

The Creative Cloud business is benefiting from a secular shift toward a visual-heavy world. Picture-heavy social media apps like Snap Inc (NYSE:SNAP) and Instagram are in. Word-heavy social media apps like Twitter Inc (NYSE:TWTR) are out. This consumer shift from words to pictures is upping demand for professional visual content creators while simultaneously creating a whole new class of amateur visual content creators. That is why growth rates in this business are consistently north of 30%.

The Document Cloud business is benefiting from the secular shift toward digital documents. Paper businesses are increasingly digitized due to cost-savings, environmental friendliness and the advancement of cloud-hosted technologies. As this shift accelerates, Adobe’s Document Cloud business will continue to roar higher. Revenues here are growing in the 10%-plus range.

The Experience Cloud business is benefiting from the secular shift toward leveraging data to deliver enhanced customer experiences. As companies continue to leverage data to deliver more personalized customer experiences, Adobe’s Experience Cloud will continue to grow. Revenues in this segment grew 26% in the previous quarter.

All in all, Adobe finds itself on the right side of many secular shifts. Plus, there really isn’t much competition in this space because Adobe is so dominant. Mitigated competitive risks coupled with exposure to secular growth markets make ADBE stock very attractive.

Valuation Still Makes Sense on Adobe Stock

Before this big jump, ADBE was trading around 36-times this year’s earnings estimate of $4.22. Earnings growth over the next several years was pegged at 20%. That gave ADBE stock a price-earnings/growth (PEG) ratio of about 1.8.

Now, ADBE stock trades at a much richer 39.5-times fiscal 2017 earnings multiple. But earnings growth has also come up. The strong fiscal 2018 guide implies that earnings growth over the next several years will look something like 25% to 30%. At the midpoint, ADBE stock now has a PEG ratio of about 1.4.

Essentially, ADBE stock is more attractively valued now than it was prior to this big pop.

Meanwhile, the S&P 500 is trading at 19.5-times 2017 earnings on roughly 11% earnings growth projections over the next several years. That gives the market a PEG ratio of about 1.8, significantly above Adobe’s PEG ratio.

Bottom Line on ADBE Stock

Its up big, but it’s not too late to join the party. ADBE stock is in the middle of a secular bull run. With growth catalysts in place for many years to come and a valuation that remains reasonable, ADBE stock has a clear path to continue to its run higher.

As of this writing, Luke Lango was long ADBE.

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