The software market is headed for a fall. I know this is true because anything that’s working is ridiculously overpriced. Take Adobe (NASDAQ:ADBE) for example. Great company. Great people. Great products. Great strategy. Moving to the cloud early, linking up with Microsoft’s (NASDAQ:MSFT) Azure, has delivered for CEO Shantanu Narayen and his team. It has also led to great success for ADBE stock. But when you look into it a bit deeper, the bullish case gets murkier.
Adobe has a market cap of $217 billion and the company expects sales of about $12 billion this year. Its price-to-earnings ratio is nearly 60.
That’s too high.
I’m not going to pretend I’m invulnerable to the next tech wreck on companies like Adobe.
My personal portfolio now consists of only tech stocks. Because tech stocks are all that’s working.
Adobe is a fine example of that. Since the start of the year, it’s up 37%. Over the last year, it’s up 49%. Over the last two years the gain has been 83%. The five-year gain has been 461%.
I’m a long-time fan of Adobe. I saw an opportunity back in September 2017 when it fell after earnings. When it fell in 2018, after missing earnings estimates by a penny, I shouted buy. I called it “a king among cloud companies” in 2019. I only began cooling on it, strictly based on its valuation, in March.
Adobe isn’t alone in being overvalued. All the big software stocks are. It’s because software scales when distribution costs fall to zero in a way nothing else does. You get the same value using Adobe Creative Cloud today that you did a month ago. You won’t say the same for this story. Only the best content holds its value, and even Gone With The Wind is no longer what it was.
But that doesn’t make software’s value infinite.
Why Is There Air in This Bubble?
The latest software bubble was caused by the Federal Reserve. They threw trillions of dollars into the market in March. The aim was to bail out companies who were hit by coronavirus through no fault of their own. The result was to support, not only what wasn’t working in the pandemic, but what was.
Software is working.
There are still writers pounding the table for software stocks. ADBE stock is one of them. But the valuation is no longer reasonable.
Adobe had just $4.3 billion in cash at the end of March. Its growth rate is steady at 23% per year, but gross income has been declining slowly. Operating cash flow has averaged $1.2 billion per quarter over the last year, free cash flow just slightly less. The most recent earnings report, delivered June 11, was strong and in-line with analyst estimates.
Whether you’re looking at chart patterns or fundamentals, there is a lot to like about Adobe.
But nothing climbs to the sky.
The Bottom Line on ADBE Stock
What might pop the software bubble?
My guess is it will be the realization that the customers aren’t doing well.
Clouds and software provide productivity. But if there’s only a finite amount of work to be done, productivity becomes unemployment. The size of the economy isn’t increasing, it is decreasing. Even if software is taking more of that economy, those gains are limited.
This could also end as the economy recovers. Once other sectors start working, the software bubble might naturally deflate. Money will drift back into airlines, hotels, casinos and cruise ships.
Right now, software looks safe. You can even enjoy a return, something you can’t do with a loan. It’s a perfect storm, and software is riding it. But buying high to sell low is no way to make money.
Dana Blankenhorn has been a financial and technology journalist since 1978. His latest book is Technology’s Big Bang: Yesterday, Today and Tomorrow with Moore’s Law, essays on technology available at the Amazon Kindle store. Write him at email@example.com or follow him on Twitter at @danablankenhorn. As of this writing he owned shares in MSFT.