By my count, Adobe Systems Incorporated (NASDAQ:ADBE) hasn’t missed analyst earnings expectations since its Q3 fiscal 2014 report, more than three years ago. And so it’s little surprise that the ADBE stock price has soared, gaining 133% over the past three years and a cool ~70% so far in 2017.
Now, the question facing ADBE stock is the same facing so many after thirteen-plus months of torrid gains: is the ADBE stock price simply too high? It’s a question worth asking. ADBE trades at over 30x its FY18 non-GAAP EPS guidance of $5.50, even backing out the company’s roughly $8 per share in net cash.
Growth of late, including 25% revenue growth and a 43% increase in EPS in fiscal 2017, seems to support that multiple. But Adobe is a company that not that long ago, was showing declining earnings. Meanwhile, James Brumley argued just last week that the technical picture looked rather weak for ADBE stock, suggesting a potential near-term pullback.
But there’s more than enough here to support more upside for ADBE, even after a strong 2017. I agree with Luke Lango that Q4 results this month did nothing but strengthen the bull case for ADBE stock. Valuation might sound high, but in the context of tech sector valuations and earnings growth, it’s actually rather reasonable.
Adobe’s transition to the cloud continues to drive growth, and a return to the bad old days of 2012-2013 seems unlikely at best. ADBE stock might not be cheap, necessarily, but it’s still worth buying.
Broad Strength for Adobe
What’s most notable about Adobe is that it’s a company worth $86 billion whose best days might be in front of it, not behind it. Revenue grew 25% in FY17 and is guided to rise closer to 20% in FY18. But there are plenty of long-term opportunities here as well.
In what the company calls Creative Cloud, Adobe simply dominates the market with programs like Photoshop and Illustrator. And with the move to cloud from ‘on-premise’ installations, that dominance is turning into increasing revenue.
Revenue rose 31% in FY17, per the Q4 conference call. More programs are coming, including Adobe XD for user interface design, and Adobe Dimension for 3D creations.
More broadly, the transition to cloud hasn’t just shifted how revenue is generated. The ease of use from cloud is driving more usage, and more revenue per user. And it cements Adobe’s leadership in a category that likely is going to grow for years, if not decades.
Elsewhere, the news is solid as well. Document Cloud is expanding the dominance of Acrobat’s ubiquitous PDF files. Experience Cloud includes Adobe’s marketing platform, which brings it into head-to-head competition with Salesforce.com, Inc. (NYSE:CRM) and Oracle Corporation (NYSE:ORCL), among others.
Adobe is winning there as well, with 24% revenue growth this year, boosted in part by last year’s acquisition of TubeMogul. Add to that the AI opportunity from Adobe Sensei, a competitor to Watson from IBM (NYSE:IBM), and Adobe has a long runway for growth.
It’s an attractive combination: dominance in the legacy markets, and greenfield opportunities in growing new markets. It’s not a combination on offer from very many stocks. And yet the ADBE stock price is in line with the sector as a whole.
ADBE Still Looks like a Buy
A 30x+ forward multiple doesn’t sound inexpensive. But given growth expectations, it will be soon. Looking forward to fiscal 2019, analysts are expecting $6.76 in EPS. That in turn suggests a forward multiple closer to 24x.
In the tech space, that’s not a very large number. It’s only modestly higher than the multiple assigned Microsoft Corporation (NASDAQ:MSFT), who has benefited from its own shift to the cloud but whose growth is well behind that of Adobe.
Admittedly, both KO and PG look overvalued to my eye. But the broad point here is that it’s not as if Adobe has some sky-high valuation that will require years of growth to satisfy. With huge margins, and heavy recurring revenue, a high 20s or low 30s multiple going forward isn’t out of the question.
That in turn suggests ADBE could, or even should, clear $200 over the next 12 months.
That’s about 15% upside from current levels. And while that pales in comparison to the 70% gains seen this year, it’s still a solid figure. A few more earnings beats, and rising analyst estimates could add to the gains.
But the broad point is that the valuation isn’t out of hand, or close. Adobe is a premium stock, based on its growth opportunities, margins, and balance sheet. It’s not being valued quite that way, however. At some point it will be – and that point likely will result in the ADBE stock price starting with a ‘2’.
As of this writing, Vince Martin has no positions in any securities mentioned.