If you want returns that beat the market, buy Adobe (NASDAQ:ADBE) stock.
Adobe stock is up 32% so far in 2021. This handily beats the average S&P 500 stock’s 18% gain. Over the last two years Adobe stock is up 137%. Over the last five years, it’s up a whopping 368%.
That’s remarkable for a company founded in 1982 around Desktop Publishing. Most companies Adobe’s age have their tombstones in corporate graveyards. Adobe’s shareholders are in hog heaven.
Credit one weird trick engineered by Shantanu Narayen, who became CEO in 2005. Narayen committed Adobe software to the cloud and that has made all the difference.
Graphics Dominance
Before 2011 Adobe was known as a “roll-up” of graphics-oriented software packages. Aldus, Allaire, Photoshop and Macromedia are just four among dozens of companies acquired before 2011.
The cloud let Adobe offer complete suites, sold by monthly subscriptions, starting with its Creative Cloud. Narayen was able to consolidate the graphics space, then extend it through business-oriented applications like Magento, Marketo and Workfront. Adobe subscriptions are now a must-have for any company doing creative work in marketing, video or their offshoots.
The result has been steady, profitable growth. Adobe was able to bring 29% of its revenue to the bottom line in the February quarter, growing revenue 23% year over year. It had the same revenue growth in the May quarter. (Adobe’s fiscal year runs from December to November.)
The balance sheet at the end of May showed $5.7 billion in cash covering $4.6 billion in long-term debt. The company is due to report for its third quarter on Sept. 21. Analysts expect $3.9 billion in revenue and $3.01 per share of earnings. There’s a “whisper number” of $3.08 per share. Adobe usually beats it. The analysts say Adobe has a unique ability to deliver 20% annual growth and margins of 40% by being in the cloud.
The Liege Lord
If there’s a vulnerability to ADBE stock, it’s a tight partnership with Microsoft (NASDAQ:MSFT) and the Azure cloud.
The partnership is more than landlord-tenant. It includes tight integration between Adobe and Microsoft tools, like its customer relationship management (CRM) software and Office 365 suite.
At a time when many cloud application companies like Salesforce (NYSE:CRM) and Oracle (NASDAQ:ORCL) are building their own data centers, Adobe continues to rent. Adobe Cloud isn’t sold the clouds of Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL) or Amazon (NASDAQ:AMZN). If the Microsoft relationship becomes strained, Adobe has no leverage. With a market cap of $315 billion, Adobe would only be vulnerable to a takeover by Microsoft, now worth $2.2 trillion.
Despite all this, analysts love ADBE stock. Of 20 following it at Tipranks, 18 tell their investors to buy it, although their price target is roughly where it trades now.
The Bottom Line for ADBE Stock
The choice Narayen made to wed Adobe to Microsoft’s cloud has been great for both companies. It has made acquisitions like Omniture, a Web analytics company bought for $1.8 billion 10 years ago, highly profitable. It has made Adobe a competitor in business applications against Salesforce and Oracle.
It has also made acquisitions like a recent $1.275 purchase of Frame.io, a video collaboration tool, simple bolt-ons. Adobe has also added stock-content marketplace Fotolia and social media site Behance.
It’s a big moat, deep and wide. But it’s a castle inside a castle, and the bigger castle belongs to someone else. Nothing wrong with it, just a business choice Adobe made a decade ago. It’s one weird trick it can’t unmake.
On the date of publication, Dana Blankenhorn held long positions in MSFT and AMZN. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Dana Blankenhorn has been a financial and technology journalist since 1978. He is the author of Living With Moore’s Law: Past, Present and Future available at the Amazon Kindle store. Write him at danablankenhorn@gmail.com or tweet him at @danablankenhorn. He writes a Substack newsletter, Facing the Future, which covers technology, markets, and politics.
