In a market that’s near its all-time highs, there are a number of stocks like Adobe (NASDAQ:ADBE). There’s little doubt that Adobe has an attractive business with excellent growth prospects. The argument comes down to what ADBE stock price should be.
ADBE stock isn’t cheap. The company’s guidance, which it updated after its strong Q1 earnings report, indicates that the price-earnings ratio of Adobe stock, based on expected fiscal 2019 adjusted earnings per share, is 35. Among 56 U.S.-listed stocks with a market cap over $125 billion, only three – PayPal (NASDAQ:PYPL), Netflix (NASDAQ:NFLX), and Amazon.com (NASDAQ:AMZN) – have a forward P/E ratio that’s higher than ADBE’s 28.4.
But Adobe almost certainly belongs in that group. And in the context of its current growth and its opportunities, ADBE stock price actually doesn’t seem excessive at this point. I’ve been a fan of Adobe stock for a long time, and ADBE stock has continued to rise for years. Right now, it doesn’t look like that will change.
Why ADBE Stock Price Is Cheap Enough
One simple comparison highlights why Adobe stock is, at worst, cheap enough to consider. Again, ADBE trades at 35 times this year’s expected EPS, and 28 times analysts’ average 2020 EPS estimate. For a large-cap software play, that’s simply not that expensive.
Indeed, look at Microsoft (NASDAQ:MSFT), an Adobe cloud partner and a long-rumored potential buyer of the company. Microsoft – even excluding its almost $8 per share in net cash – trades at 26 times analysts’ average fiscal 2019 EPS estimate and over 23 times their FY20 consensus EPS estimate.
Should Adobe stock be trading at a higher valuation than Microsoft stock? Absolutely. ADBE’s growth going forward should be far more impressive. Adobe’s adjusted earnings per share, according to analysts’ average projections, should rise 23% next year, more than double Microsoft’s anticipated increase. Both companies have benefited from the shift to cloud-based services, but Adobe has much lower exposure to flattish consumer PC revenue.
This data doesn’t mean ADBE stock price is cheap. Indeed, I was skeptical toward Microsoft stock for some time before turning bullish on it last year. The recent run of Microsoft stock to a near-trillion-dollar market cap makes MSFT once again somewhat dicey from a valuation standpoint.
But the valuation gap between MSFT and ADBE stock is, at worst, reasonable. If Adobe ‘s EPS continues to rise at a 20%+ annual rate, that gap will disappear in just a few years. Put another way, 35 times this year’s earnings for ADBE stock might sound expensive. But Adobe’s EPS looks poised to reach $12 by 2021. At current levels, ADBE stock is trading around 23 times $12. A multiple of 23 times for ADBE stock sounds close to cheap.
Growth Drivers for Adobe Stock
The ADBE stock price is, at worst, in a range that will enable Adobe to grow into its valuation and then rise further. ADBE is not quite priced for perfection, as some may believe.
If ADBE’s growth continues, Adobe stock should rise and outpace the market. And there are plenty of reasons to expect that ADBE’s growth will continue. Creative Cloud demand is only going to grow as creative jobs multiply amid the growth of streaming media and small businesses, i.e the customers of Shopify (NYSE:SHOP) and Etsy (NASDAQ:ETSY).
ADBE’s Experience Cloud – boosted by the acquisitions of Marketo and Magento last year – will continue to expand its addressable market and benefit from the increasing importance of data analytics and the increasing breadth of marketing channels, including digital marketing.
Adobe should benefit from many of the trends that have driven tech stocks, in particular, to their current valuations. The shift to cloud? Check. Digital advertising growth? Check. Big data? Check . If an investor is going to pay up for exposure to those trends, ADBE stock is a logical choice for him or her.
Watch the Market
The biggest risk to ADBE, in fact, seems to be external. At some point, investors may bring stock valuations down across the board. (But I’d note that risk has been seemingly ever-present for the past decade,.) The ADBE stock price dropped by more than 25% in the market-wide swoon late last year, so it’s not immune to broad market weakness.
But any investor owning pretty much any tech stock at the moment is taking some sort of valuation risk. And there doesn’t appear to be many tech stocks as appealing as ADBE. Adobe stock isn’t cheap, but it shouldn’t be, at least not yet. And if it keeps doing what it has been doing, $267 will seem cheap in retrospect.
As of this writing, Vince Martin has no positions in any securities mentioned.