Adobe Continues to Justify Its Rich Stock Valuation

Adobe (NASDAQ:ADBE) wrapped up another solid quarter, reporting record revenue and exceeding analysts’ earnings estimates by a fair margin when it reported third-quarter results in September. ADBE stock sold off following the announcement but has since snapped back. Many have criticized the stock for its rich valuation, but it’s well worth it with multiple growth drivers, robust fundamentals and an incredible outlook.

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Adobe is one of the most diversified companies in the market, producing software that fulfills various digital content creation needs. Its transition to a software-as-a-service (SaaS) model has paid a lot of dividends for its shareholders. If you had bought ADBE stock five years ago, you’d be sitting on a gain of more than 500%.

The company has a wide competitive moat, with its enterprise offerings experiencing healthy growth. Though the stock trades at more than 19 times forward sales, it boasts a mammoth addressable market of over $147 billion. Moreover, it has plenty of growth catalysts that will continue expanding its top and bottom lines.

Adobe’s Hugely Successful Business Model

Adobe’s strength lies in its highly efficient SaaS business model. It essentially allows its users to access its suite of products without taking ownership of the software.  The effectiveness of the model is such that the company’s gross margin is an astonishing 88%.  Moreover, almost 100% of its creative software sales, its largest business, is derived from its subscription model. At its current pace, analysts expect earnings per share to increase 18% a year over the next five years.

Furthermore, Adobe is likely to benefit from digitalization and content creation trends. Social media usage boomed during the pandemic, which led to a massive increase in online content creation. Adobe offers a one-stop shop for its users for developing high-quality content, all of which can be accessed in the cloud.

Moreover, Adobe keeps investing in new features to refine its products and enhance the stickiness of its services. It invests heavily in AI and machine learning to develop new features to prepare for the boom in augmented reality (AR) and 3D content. The spread of AR and virtual reality (VR) will lead to more 3D content creation, playing right into Adobe’s hands. The ultimate objective is to drive more growth and increase average spending per user for higher-priced products.

A Highly Profitable Business With a Pristine Balance Sheet

Adobe has been one of the fastest-growing businesses in its industry, expanding its annual revenue base at an amazing pace. It’s also wildly profitable. The company has been generating incredible profit margins of over 20% for most of the past decade. With an unmatched suite of subscription-based services, it is poised to continue growing at a healthy pace for the foreseeable future.

The company boasts a cash balance of $6.16 billion, offset by $4.7 billion in debt. Moreover, it has generated upward of $6 billion in free cash flow in the past 12 months alone.

Management also returns a lot to its stockholders. Though the company doesn’t pay a dividend, it has authorized a $15 billion stock repurchase plan through fiscal year 2024. In the third quarter, the company bought back 1.7 million shares.

Even with an aggressive share repurchase program, Abode has plenty of wiggle room to invest in new software.  For instance, it recently proposed terms to acquire video collaboration software platform, which has more than a million users. Hence, Adobe is in a pole position to lead its users into a new digital era.

The Bottom Line on ADBE Stock

Adobe is among the cream of the crop as far as software companies are concerned. It continues to grow its top and bottom line at an impressive pace while strengthening its balance sheet. Moreover, its investments in AI will help it gain handsomely from the digitalization and content-creation trends.

Hence, ADBE stock is a buy despite its lofty price point.

On the date of publication, Muslim Farooque did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the Publishing Guidelines

Muslim Farooque is a keen investor and an optimist at heart. A life-long gamer and tech enthusiast, he has a particular affinity for analyzing technology stocks. Muslim holds a bachelor’s of science degree in applied accounting from Oxford Brookes University.

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