Adobe (NASDAQ:ADBE) stock has been a big winner on Wall Street for a long time. Over the past decade, ADBE stock has risen more than 1,000%.
The digital-tools giant recently reported second-quarter numbers which showed that ADBE stock will remain a big winner on Wall Street for a long time.
The quarter included the months of March, April and May, the three worst months of the novel coronavirus pandemic, during which much of the global economy shut down.
Against that backdrop, Adobe managed to report:
- 14% revenue growth.
- a gross margin gain of 1.1 percentage points.
- an operating margin increase of 4.4 percentage points.
- earnings per share growth of 34%.
That’s impressive. It shows that demand for Adobe’s three core products is robust enough to grow rapidly despite a world-stopping pandemic. The company’s three main products are Creative Cloud (which enables content creators to create professional-quality visual media), Digital Cloud (which enables enterprises to accelerate and optimize their paper-to-digital transformations) and Experience Cloud (which equips brands with best-in-breed tools to digitally engage with their customers through visual mediums).
More importantly, robust demand for those core offerings will persist for the next five to ten years. As a result, Adobe’s revenues and profits will grow.
And, as that happens, ADBE stock will maintain its winning status on Wall Street.
Adobe’s Strong Earnings
Adobe’s Q2 report was very strong.
In the midst of a global pandemic and a recession, Adobe managed to report strong revenue growth, meaningful margin expansion and rapid profit growth.
Its total revenue rose 14% year-over-year, driven by the 17% growth of its Creative Cloud unit and the 22% growth of its Digital Cloud segment. Those two businesses generated huge growth partly because, amid widespread stay-at-home orders, creating social content became more popular. As a consequence, demand for Adobe’s Creative Cloud tools which help consumers create high-quality social content increased.
Further, as physical offices closed across the world, enterprises accelerated their digital transformations, boosting the demand for Adobe’s digital enterprise solutions.
The company’s Experience Cloud business didn’t perform as well; its revenues rose just 5% year-over-year in Q2. But that’s mostly because of depressed advertising and marketing spending by companies. That decline, in turn, was driven by the fact that consumers simply weren’t spending money on anything besides groceries and hand sanitizer.
Over the next few months, however, consumer discretionary spending will rebound. Marketing and advertising spending will rise, too, boosting Adobe’s Experience Cloud business.
Adobe’s gross margins were lifted by the company’s decision to phase out less profitable ad sales amid depressed demand for those solutions. Additionally, Adobe reduced its discretionary and travel spending.
The firm’s operating margins expanded more than four percentage points, and its earnings per share rose 34% YOY.
Needless to say, Adobe did a stellar job managing the Covid-19 crisis.
Non-Cyclical Growth Drivers
Adobe’s long-term growth outlook is supported by non-cyclical demand drivers which will remain robust for the next five to ten years.
Its Creative Cloud business will continue to do very well over the next few years because the world is increasingly relying on visual aids to communicate, especially on social networks, such as Snap (NYSE:SNAP). Pinterest (NYSE:PINS). Facebook’s (NASDAQ:FB) Instagram, and Tik Tok. Those are the world’s hottest social platforms today, and they all incorporate a great deal of visual content.
Consequently, as social communication increasingly becomes more visual over the next several years, demand for Adobe’s Creative Cloud tools — which help people make visual media — will continue to soar.
Meanwhile, the Document Cloud business helps firms accelerate and optimize their paper-to-digital transformations. Those transformations will only accelerate in the wake of the Covid-19 crisis, as companies increasingly pivot towards cloud-hosted workflows and digital documents. As that happens, demand for Adobe’s Document Cloud solutions will accelerate.
And lastly, the Experience Cloud business enables companies to digitally engage with customers through visual tools. Demand for its solutions will continue to soar, too, because as consumers increasingly spend time on social platforms, brands will have to increasingly create strong visual content to reach those consumers.
So Adobe is the dominant player in three non-cyclical growth markets. That positions the company and ADBE stock for long-term success.
Adobe’s Stock Is Undervalued
Although Adobe seems expensive, it’s not. It’s actually undervalued.
Adobe is trading at 16 times its trailing sales, 40 times its cash flow, 17 times its book value, and 40 times its forward earnings, based on analysts’ average 2020 earnings per share estimate. It’s easy to look at those multiples and say that ADBE stock is overvalued.
But that simple analysis misses one very important point: Adobe is growing quickly enough, at a sufficient profit margin, to warrant those high multiples.
Over the next several years, thanks to favorable demand drivers, Adobe will sustain 10%+ annual revenue growth. Its gross margins will rise due to strong demand and gradual price hikes, while its growth will improve its profitability
All in all, its earnings per share will surge at least 15% through 2025. Consequently, I estimate that Adobe’s earnings per share can reach about $20 by 2025.
The stock’s historical average forward earnings multiple is around 30. Based on that average multiple and a 10% annual discount rate, 2025 EPS of $20 implies a 2020 price target for ADBE stock of $410.
Thus, below $400, Adobe stock is undervalued.
The Bottom Line on ADBE Stock
Adobe has been a big winner on Wall Street for a long time. The company’s Q2 earnings report confirmed that Covid-19 didn’t change this reality. Instead, it may have actually helped Adobe by creating more demand for visual-oriented and digital products.
So Adobe will remain a big winner on Wall Street for at least the next several years.
Investors should stick with this rally. They’d be hard-pressed to find a better growth name in the market than ADBE stock.
Luke Lango is a Markets Analyst for InvestorPlace. He has been professionally analyzing stocks for several years, previously working at various hedge funds and currently running his own investment fund in San Diego. A Caltech graduate, Luke has consistently been rated one of the world’s top stock pickers by various other analysts and platforms, and has developed a reputation for leveraging his technology background to identify growth stocks that deliver outstanding returns. Luke is also the founder of Fantastic, a social discovery company backed by an LA-based internet venture firm. As of this writing, he was long ABDE, SNAP, and PINS.