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Stock Analysis & Ideas

Adobe: Excellent Growth, but Be Wary of Valuation

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Adobe (ADBE) has consistently positioned itself for the future of digital media and digital marketing, with the company basically monopolizing the digital media industry with its Creative Cloud.

Adobe’s key competitive advantage arises from leveraging the perks of its recurring SaaS revenue model, supplying its software and tools through a monthly subscription. The company’s creative suite combines the most superior and complete tools in the industry, incorporating Photoshop, Illustrator, and After Effects, which are universally regarded as must-haves for essentially any type of digital creator.

Due to the comprehensive nature of Adobe’s suite, the company features a deep moat, letting no room for any potential competition to emerge. Even then, professionals would hardly switch from a trusted service to risk the quality of their projects.

While I love Adobe both as a company and as a stock, investors should be wary of its pricey valuation, which could potentially weigh down on total returns. I remain bullish on the stock, though investors should not ignore the risks attached to its premium multiple. (See Analysts’ Top Stocks on TipRanks)

Q3 Results – Excellent Growth Persists

Adobe’s reported its Q3 results back in September, with revenues once again growing impressively by 22% year-over-year to $3.9 billion. Non-GAAP diluted earnings per share increased 21% versus the prior-year period as well, reaching $3.11 with net income margins standing at an impressive 30.8%.

In my view, what’s truly remarkable about these numbers is that many had speculated that Adobe’s growth would decelerate considerably. The reason for this was due to the company benefiting from the one-off boost of COVID-19 last year, which substantially boosted the digital economy and the digital creative industry.

However, Adobe once again proved that its all-in-one suite can attract new subscribers consistently and extract more dollars from each subscriber due to all the add-ons it provides to creators.

Specifically, the Digital Experience segment posted revenues of $985 million, suggesting growth of 26% year-over-year. In comparison, the Digital Experience subscription revenue came in at $864 million, representing 29% growth versus the comparable period last year.

Further, the company’s outlook for Q4 included expected revenue growth of ~20%. Considering Adobe’s tendency to beat its guidance estimates, is more likely to land around 22% again, indicating that its robust growth pace is set to remain as we advance.

The Valuation

Over the past couple of weeks, Adobe has rallied towards new all-time highs, with its shares almost touching $700. Based on the company’s results over the past nine months, analysts estimate FY2021 EPS of around $12.47.

Indeed, Adobe’s Q3 numbers were once again excellent, in my view. That said, the stock continues to rally disproportionally higher than the company’s financial growth, which has resulted in a troubling valuation expansion.

Adobe is currently trading with a P/E of 53 based on this year’s expected EPS, which is notably higher than its historical average of just over 30. We cannot ignore that revenue growth is likely to remain strong, which could lead to the stock growing into its valuation in the medium term.

Also, I continue to view Adobe as a high-quality company that deserves a place amongst all growth portfolios. Hence, I am a long-term bull on the stock. Still, Adobe features a reduced margin of safety at its current levels, which investors should be wary of.

Wall Street’s Take

Turning to Wall Street, Adobe has a Strong Buy consensus rating, based on 19 Buys and four Holds assigned in the past three months. At $727.76, the average Adobe price target implies 9.4% upside potential.

Disclosure: At the time of publication, Nikolaos Sismanis did not have a position in any of the securities mentioned in this article.

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