Over the past several months and years, few stocks have been as strong as Adobe Systems Incorporated (NASDAQ:ADBE). Ever since the professional creative solutions company migrated its entire business to the cloud in 2013, it has been nothing but up, up, and away for Adobe stock. Since then, Adobe stock is up 500%.
And the story just keeps getting better.
ADBE just reported first quarter numbers last week. They were really good. So was the guide. Revenue growth refuses to slow down in any meaningful way. Gross margins are running higher thanks to subscription price hikes. Operating margins are likewise zooming higher. Same with earnings.
Adobe stock jumped after that report. It is now at $225, an all-time high, and up 30% on the year.
Bears will scream about the rich valuation. But like its hyper-growth cloud peers, Adobe stock has a big and long enough growth runway to grow into that valuation.
Big takeaway? Adobe stock can and will head higher, even from these fresh all-time highs. Here’s a deeper look.
Adobe Is a Big Growth Company with Little Competition
There are two really attractive features about ADBE:
- The company is attacking a massive market, implying sizable revenue growth potential into the foreseeable future.
- The company has very little formidable competition in that massive market, implying sizable margin expansion potential into the foreseeable future.
On the first point, Adobe’s revenues were just over $7 billion last year. But between the company’s three major business (Creative Cloud, Experience Cloud, and Document Cloud), ADBE management pegs the company’s total addressable market at $83 billion.
This small total addressable market penetration (<10%) is probably why ADBE’s revenue growth just refuses to slow down despite consistently being over 20%.
Indeed, last quarter, revenue growth actually accelerated versus the same quarter in the prior year (24% in 1Q18 versus 22% in 1Q17).
Because the addressable market is so big relative to ADBE’s current size, the only thing that could stop Adobe stock at this point is competition. But competition has yet to show up, and it likely won’t show up anytime soon.
Adobe has developed a unique dominance in the professional creative solutions world. Essentially, Adobe is so good that there is no viable alternative.
Just check out this list or this list of Adobe Photoshop alternatives. None of them are household names, nor are any of them formidable competitors to Adobe. If you are a creative professional, you’re going to subscribe to Adobe’s cloud-hosted solutions.
That is why Adobe saw essentially zero churn when they started migrating their business to the cloud in 2013. Adobe users were initially angry when Creative Suite went all-cloud, all-subscription. That meant consumers would have to pay fees into perpetuity to use something that formerly was just a one-time cost.
But users got over that anger because there was no other product out there that rivaled Adobe’s Creative Suite. Creative professionals started paying the recurring fee, and never stopped paying it. And that is why Adobe’s subscription revenues have grown by more than five-fold over the past four years.
The same thing is happening across all aspects of ADBE’s business, from the Creative Cloud to the Document Cloud to the Experience Cloud. In each of these business, revenues are soaring because Adobe offers unparalleled solutions in an increasingly digitally-connected, visual-first, data-driven world.
Big market potential plus mitigated competition leads to a healthy outlook for big revenue growth to persist into the foreseeable future. Moreover, that is also a healthy combination for margin expansion. Because there is very little competition, ADBE can hike prices on its subscription fees without users churning.
Price hikes are a huge margin driver. Just ask Netflix, Inc. (NASDAQ:NFLX).
Bottom Line on ADBE Stock
Bears don’t like the valuation on ADBE. The stock trades at 36-times guided 2018 earnings.
That is a big multiple. But revenue growth is expected to remain around 20% for several years, and reasonably so considering the large addressable market and lack of competition. Big margin drivers should turn that 20% revenue growth into 25-30% earnings growth over the next several years.
A 36-times multiple on 2018 earnings isn’t that bad for 25-30% earnings growth. It is actually quite reasonable for a secular growth cloud stock.
All in all, Adobe has been a big time winner. The growth story is only strengthening, and the valuation is still reasonable. Therefore, Adobe stock will remain a big time winner.
As of this writing, Luke Lango was long ADBE.
