Time and time again over the past several years, I’ve called technology behemoth Adobe (NASDAQ:ADBE) a long-term winner: buy on dips, hold onto for the long haul. That’s the strategy I’ve preached with Adobe stock since 2017.
During this stretch, Adobe stock hasn’t disappointed. In 2017, the S&P 500 rose less than 20%; meanwhile Adobe stock rallied more than 70%. In 2018, while the S&P 500 dropped 6%, Adobe stock rose 29%. Last year, the S&P 500 had a great year, rising 29%. But, it still didn’t top Adobe stock, which rallied 46%.
Three straight years of significant out-performance for Adobe stock. The streak won’t stop here. Instead, when all is said and done in 2020, Adobe stock will notch its fourth straight year of big out-performance. Here’s why.
Adobe’s Business is on Fire
Adobe’s business breaks down into three segments. All three are on fire, have plenty of room to grow, and are supported by attractive financial profiles.
First up, there’s Adobe’s bread-and-butter, the Creative Cloud. This is the suite of digital media capture and editing solutions which Adobe has become known for both near and far, including Photoshop, Lightroom, Premiere Pro and others. These solutions are seeing rapid uptake among both individuals and enterprises, because the world is becoming more visual-focused, forcing media creators to increasingly allocate resources to media capture and editing solutions.
Given that this trend won’t break anytime soon and that Adobe management pegs the addressable market here at $33 billion, Adobe’s Creative Cloud growth momentum won’t ease in the foreseeable future. It’s also worth noting most of these solutions are high-margin, subscription-based solutions, so Adobe is taking home a lot of gross profit from each subscription sale.
Second, there’s Adobe’s other major earner, the Document Cloud. This is where Adobe is powering the enterprise paper-to-digital transformation by leveraging the ubiquitous PDF format to make the editing, sharing, scanning, and signing of documents a friction-less process across desktop and mobile. There’s no doubt that digital is the future of the enterprise document world. Sure, Adobe has a ton of competitors in this space — see the redhot DocuSign (NASDAQ:DOCU).
But the addressable market here is quite big (around $13 billion), and Adobe is one of the top dogs in the space. So long as Adobe remains one of the top dogs — and they should, given the company’s tremendous resources and ability to integrate with other solutions — then the Document Cloud business will similarly sustain big growth for a lot longer as enterprises continue on their paper-to-digital transformations.
Experience Cloud Upside is Promising
Last but not least is the Experience Cloud business, where Adobe is becoming a leader in Customer Experience Management (CXM).
This is perhaps the most promising and exciting piece of the Adobe growth narrative. Long story short, CXM is the future of marketing in a world where what you sell is just as important as how you sell it (or, where the product is just as important as the customer experience). Consequently, enterprise spend on CXM software will rise by leaps and bounds over the next several years, so much so that Adobe management pegs the addressable market for its Experience Cloud business at $84 billion.
Adobe is tapping into a tiny portion of that today. Digital experience revenue was just $3.2 billion last year. But, that number was up 31% year-over-year. It will continue to grow at a robust pace, because Adobe is emerging as a CXM leader at a time when CXM software spend is accelerating higher.
Looking out long term then, Adobe has a compelling opportunity to turn its $3.2 billion Experience Cloud business into a $10 billion-plus business with big gross margins one day.
Adobe Stock is still Undervalued
Given the company’s powerful multi-faceted growth drivers, Adobe stock is still undervalued today.
The numbers aren’t too hard to break down here. Revenues rose 25% in 2017, and 24% in both 2018 and 2019. Consensus sell-side estimates call for 18% revenue growth this year, 16% growth in 2021 and 13% growth in 2022. Given Creative Cloud and Document Cloud momentum, as well as CXM upside potential, it seems likely that Adobe sustains 10%-plus revenue growth thereafter into 2025.
Assuming so, 2025 revenues will likely pan out somewhere around $25 billion. Over this same stretch, gross margins will remain elevated around 90%, thanks to the company’s strong market positioning as well as favorable subscription-based model. Expense growth will likely continue to moderate, and sustained double-digit revenue growth will drive positive operating leverage. Operating margins should consequently move higher and push profit growth into the 15%-plus range.
Under those realistic assumptions, Adobe’s fiscal 2025 earnings per share should come out around $21. Based on a 25-times forward earnings multiple — the sector average for systems software stocks — that implies a 2024 price target for the stock of $525. Discounted back by 10% per year, that equates to a 2020 price target of $360.
Thus, although it’s up 220% over the past three years, Adobe stock is still undervalued.
Adobe stock is a long term winner. There’s no simpler way to word it. Given this company’s powerful, multi-faceted growth narrative and still tangible valuation, Adobe is the type of stock you buy on dips and hold for the long haul.
As of this writing, Luke Lango was long ADBE.