Adobe Stock Is a Buy Until Proven Otherwise

There are reasons to be cautious when it comes to Adobe (NASDAQ:ADBE) stock at the moment. Adobe unquestionably is a wonderful business. Adobe stock, however, has a valuation that looks questionable.

Adobe Stock Is a Buy Until Proven Otherwise
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After rallying over 40% since October, ADBE stock now trades at nearly 38 times its adjusted earnings per share guidance for its fiscal 2020. (The company’s fiscal year ends in November).

There are 89 U.S.-listed companies with a market capitalization over $100 billion. Only three of them have a higher forward price-earnings multiple than Adobe: (NASDAQ:AMZN), Netflix (NASDAQ:NFLX), and (NYSE:CRM). AMZN and NFLX, in particular, have been among the highest-flying and most-debated stocks during the current bull market.

The P/E multiple of ADBE stock has jumped in recent months. When I recommended the stock back in May, its forward multiple was a much more reasonable 28. Even based on analysts’ average FY21 EPS estimate, the stock still has a P/E multiple of over 31.

I wouldn’t blame any investor who believes that’s too high a price to pay. But I’d disagree. Adobe, simply put, is one of the best businesses out there. Its stock shouldn’t be cheap. Meanwhile, this has been a market that has been willing to pay up dearly for growth and quality. Until that changes, ADBE can keep rallying.

The Case for ADBE Stock

Putting valuation aside, there’s almost no way to argue against Adobe stock. Its revenue grew 24% year-over-year in FY19. Its acquisitions of Marketo and Magento certainly boosted its top line. But excluding acquisitions,  Adobe’s revenue still increased at least 15% in FY19, according to a document it filed with the SEC.

Meanwhile, its profit margins are simply spectacular. ADBE’s  operating income, excluding some items,  was just shy of 40% of its revenue in FY19.

That margin is higher than Microsoft’s (NASDAQ:MSFT), which likely is the gold standard among software businesses., whose stock seemingly has been bulletproof for years, has operating margins under 20%.

In terms of business strength, few if any companies can match Adobe. And the company’s future looks bright as well. Adobe continues to expand and improve its offerings, most recently moving its website design product onto the cloud. The company’s Analytics and Adobe Advertising Cloud offerings allow it to capitalize on the “big data” trend.

Adobe’s growth is unlikely to end soon. The only real issue is its valuation.

Does Valuation Matter?

And the valuation  of Adobe stock indicates that it’s worth buying. Because, again,  quality has trumped valuation every time in this market. Whether it’s AMZN, or NFLX, or Shopify (NYSE:SHOP), or even a lower-growth, defensive name like Procter & Gamble (NYSE:PG), investors continue to pay up for quality businesses. Arguing that a stock is “too expensive” has been a foolproof way to at best miss out on big gains, and at worst lose one’s shirt trying to short stocks based on valuation.

Contrarians would respond that ignoring valuation leads to investing in bubbles — and I’m not unsympathetic to that argument. I’ve stated that price was an issue for names like MSFT and SHOP, It’s possible those arguments simply were early, not necessarily wrong.

But in a bull market that’s now in its 11th year,  there are simply no quality stocks that are on sale. Stocks that are “cheap” generally are cheap for good reasons. And I’d rather own ADBE, with 15%-plus earnings growth, at nearly 40 times its earnings than some of the “cheaper” names whose earnings are only growing at a single-digit percentage clip.

It’s certainly possible that this is the type of analysis that’s prevalent while the stock market is at its all-time highs. A stock whose valuation looks attractive relative to other overvalued names certainly may be overvalued itself. AMZN stock was a better pick than in 1999; it still took years for Amazon’s shareholders to get back to even.

Still, if an investor is going to be long stocks in this market, she is going to have to buy expensive names. And I’d rather pay up for Adobe, one of the world’s best businesses, than get cute trying to find “value” in a company that doesn’t have the same positive attributes as ADBE.

As of this writing, Vince Martin has no positions in any securities mentioned.

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