Adobe’s Strong Earnings Confirm That Adobe Stock Is a Winner

Adobe (NASDAQ:ADBE) stock popped to all-time highs in early December 2019 after the cloud giant reported fourth-quarter numbers which beat expectations.  The strength of the company’s digital media business led to the better-than-expected results. Management also delivered impressive guidance which implied that Adobe stock  won’t lose much momentum anytime soon.

STARS Stocks to Buy for the Long Run: Adobe (ADBE)

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Investors celebrated the results, and ADBE stock moved higher. It’s kept moving higher ever since. Today the shares trade hands at all-time highs above $320, up an impressive 45% in 2019.

But a 45% rally in a year is nothing new for Adobe stock. In every year since 2012 except one, ABDE stock has risen more than 20%. The one year that ADBE stock didn’t rise more than 20% was 2016, and the shares still climbed 10% that year. Further, Adobe stock jumped at least 50% in 2013 and 2017.

In other words, ADBE stock’s big gain in 2019 is a continuation of a much bigger trend during which the stock has been winning big for eight straight years. The big question now is: will it continue to win in 2020?

All signs indicate that it will. As a result, I don’t think now is the time to take profits on Adobe stock. Instead, now is the time to stay long ADBE and stick with the rally because ADBE stock will climb towards $350 in 2020.

Adobe Stock Will Win Over the Long-Term

Adobe stock has all the qualities of a long -term winner. After analyzing the company’s three components, that becomes clear.

There’s Adobe’s Creative Cloud business, which provides tools that enable everyone to create high-quality, creative content.  Growing very rapidly, this business is powered by the world’s pivot towards creative and visual media consumption. The unit has very little competition, since Adobe is, by far, the leading  brand when it comes to making and editing creative content.

Adobe’s Document Cloud business focuses on the paper-to-digital transformation across the corporate world and provides corporations everywhere with the tools to turn into fully digital businesses. The Document Cloud business is growing very rapidly, too, and is supported by the fact that paper is going extinct and digital documents are the future. Adobe has some competition in this market, including DocuSign (NASDAQ:DOCU). But the competition is not strong enough to constitute a meaningful threat.

And Adobe’s Experience Cloud business provides enterprise cloud services to digital businesses. Those cloud services are used by digital businesses to enhance their customers’ experience.  CE is all about creativity and visuals — areas in which Adobe excels — and it’s the fastest growing portion of Adobe. As  long as the world keeps pivoting towards creative and visual media, Adobe’s Experience Cloud will continue growing rapidly.

Putting all that together, Adobe is powered by three very big, very rapidly growing businesses, with huge growth prospects and muted competition. That creates the foundation for high growth, huge margins (nearly 90% gross margins for Adobe), and sustained high profit growth. Indeed, Adobe has generated 20%-plus revenue growth and nearly 90% gross margins for each of the past several years.

Adobe Stock Can Move Higher

ADBE stock is richly valued. But, considering that it will grow rapidly for the foreseeable future, the numbers actually indicate that the valuation of Adobe stock should be higher.

Adobe stock trades at 33 times its forward earnings. On its own, that’s a high forward earnings multiple. The market trades at 17 times forward earnings, and the entire information technology sector trades at around 21 times forward earnings. The systems software segment also trades at just 25 times forward earnings.

So, relative to its peers and the market, ADBE stock is richly valued.

But that’s only a part of the picture. The rest of the picture is that Adobe’s revenues are rising at a 20%-plus clip, and it should deliver 15%-plus revenue growth for the next several years, thanks to its digital, visual, and creative media catalysts. Also, Adobe has 90% gross margins and an above-average 48% operating expense rate (the average opex rate in the IT sector is about 35%), so there’s plenty of room for 15%-plus revenue growth to drive increased profitability and sizable margin expansion.

Considering all of that, Adobe’s earnings should rise by high-teen-percentage levels for a lot longer. Assuming that does occur, Adobe’s earnings per share should reach about $21 by fiscal 2025. Based on a 25-times forward earnings multiple (which is average for systems software stocks) and a 10% annual discount rate, that equates to a fiscal 2020 price target for ADBE stock of nearly $360.

Shares trade hands around $320 today, at the start of FY20. Thus, over the next 12 months,  ADBE stock can rally another 10% or more, according to my calculations.

The Bottom Line on Adobe Stock

Adobe stock will win over the long-term. Its Q4 numbers confirmed that. Its Q4 results also confirmed that this company will continue to grow rapidly in 2020. That strong growth should keep the shares on a winning track for the foreseeable future.

As of this writing, Luke Lango was long ADBE. 

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