With shares up 31% since Nov. 1, is Adobe (NASDAQ:ADBE) stock a buy at the current price level? After December’s earning beat, the company could see its impressive level of growth continue — and push ADBE stock even higher.
Currently sitting at 37.4 times forward earnings, Adobe shares sell at a rich valuation. In this runaway bull market, that hardly seems to matter. So, with the company’s growth story continuing, shares could reach new highs in the near-term.
Furthermore, it’s safe to say that with ADBE stock, you are buying a business with a tremendous economic moat. The company’s software offerings are invaluable assets. Whether we are talking about the Creative Cloud unit, Document Cloud unit or Experience Cloud, the company plays a heavy role in the new economy.
However, is buying Adobe stock today a smart play long term?
It may pay to be patient, and wait for a dip to accumulate shares. That said, let’s dive in, and see why buying later is the best call for ADBE stock.
ADBE Stock Has Gotten Ahead of Itself
As InvestorPlace’s Luke Lango discussed Dec. 19, the company’s revenue growth justified a price target of $360 per share. But now, shares trade above that price target and are closer to the $365 level. It’s tough to say the recent rise of ADBE stock is due to fundamentals. After December’s earnings beat, much of Adobe’s future upside was priced into shares. So, what’s driving the recent run-up? Mr. Market, or specifically, Mr. Broad Market.
Major indices are not slowing down even after the coronavirus panic, so it’s no mystery why ADBE stock keeps climbing higher. With its de facto monopoly on digital design, Adobe should be christened a Nasdaq Composite blue chip. Given major tech names like Microsoft (NASDAQ:MSFT) are ripping to new highs, there’s no reason to leave out Adobe shares from the fun.
However, outside of the broad market, what could send ADBE stock lower? How about the company’s projected revenue growth slowdown? As this Seeking Alpha contributor discussed, it’s hard to justify Adobe’s high forward price-to-earnings (P/E) ratio when the company’s growth rate is expected to drop below the 20% handle.
Once investors get back to using fundamentals — not momentum — to price shares, they may not be so keen on giving ADBE stock its current multiple. Yet, compared to peers, Adobe’s valuation doesn’t seem so unreasonable.
That said, let’s dive in and compare.
Does Adobe Warrant a Lower Forward Earnings Multiple?
What type of forward multiple does ADBE stock deserve? Let’s compare the company’s valuation to similar enterprises. Granted, these are not apples-to-apples peers. But, they all mature software companies with high operating margins:
- Intuit (NASDAQ:INTU): forward P/E of 38.4, FY20 (ending July 2020) revenue growth of 11.5%
- Oracle (NYSE:ORCL): forward P/E of 13.9; FY20 (ending May 2020) revenue growth of 1.1%
- Microsoft: forward P/E of 31.7, FY20 (ending June 2020) revenue growth of 13.1%
- SAP SE (NYSE:SAP): forward P/E of 22.2, FY20 (ending December 2020) revenue growth of 7.4%
Based on these peers, Adobe’s current valuation may not be so far-fetched. Oracle and SAP sell for lower multiples, but both companies are experiencing lower levels of growth. Intuit seems richly priced considering its revenue growth projections. Microsoft is also richly valued, yet with its cloud catalyst, may not be a relevant comparison.
With these in mind, its hard to say whether ADBE stock will fall to a forward P/E in the 20 to low-30’s range; Even relatively slow-growing SAP sells for 22 times forward earnings. So, outside of a market correction, we likely won’t see such a dramatic multiple contraction anytime soon.
Nevertheless, we could be reaching a point where Adobe stock “grows into its valuation”. With projected growth cooling down to the 15-20% per year range, ADBE stock could tread water as the underlying business catches up to the stock.
ADBE Stock Could Head Higher, but Don’t Expect Blockbuster Returns Going Forward
ADBE stock sells at a high multiple. Yet, its valuation is reasonable relative to peers. If the runway bull market doesn’t top out anytime soon, Adobe shares could move to higher price level. However, in terms of long-term returns, today may not be a great time to buy Adobe stock.
There’s no doubting the strength of Adobe’s underlying business. With high margins and a de-facto monopoly on digital design, the company offers investors a high-economic moat. But, as this mature company moves to slower rates of growth, ADBE stock could experience a multiple contraction — or at least, tread water over the next few years.
It’s tough to see continued multiple expansion in ADBE stock. So if you are confident the strong market will continue through 2020, consider Adobe shares today. But, if you want to get in for a more reasonable valuation, wait for a dip to buy.
As of this writing, Thomas Niel did not hold a position in any of the aforementioned securities.
