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Adobe: Great Business, Rich Valuation Multiples
Stock Analysis & Ideas

Adobe: Great Business, Rich Valuation Multiples

As a multinational software company, Adobe Inc. (ADBE) specializes in developing and commercializing software related to computer documents, photography, graphics, animations, illustrations, multimedia and video, and print. The company is headquartered in San Jose, California.

I am neutral on Adobe because Wall Street’s bullishness on the stock and its strong growth potential are offset by its rich valuation multiples. (See Analysts’ Top Stocks on TipRanks)

Strengths

Adobe has hundreds of millions of users across the world. Some of the company’s flagship products are the Adobe Reader and PDF, Adobe Photoshop image editor, Adobe Illustrator vector-based illustration tool, and a wide range of other audio and video content creation and publishing tools. The company has over 21,000 employees worldwide, 40% of whom work in San Jose.

Recent Results

For Q3 2021, Adobe announced total revenues of $3.94 billion and non-GAAP earnings of $3.11 per share, which surpassed analysts’ estimates of $3.89 billion. The figure showed an increase of 2.6% from the second quarter of 2021, and an increase of 22% from the third quarter of 2020.

The increase was due to strong momentum in the Adobe Creative Cloud, Document Cloud, and Experience Cloud segments. Meanwhile, the rapid growth of subscription revenue also resulted in higher revenues.

The company’s subscription revenue increased to $3.7 billion, showing an increase of 24.1% on a year-over-year basis. Product revenues stood at $119 million, showing an increase of 9.2% year-over-year. In addition, Services revenue was $159 million, showing a decrease of 5.3% year-over-year.

The company’s Creative Cloud segment generated revenue of $2.4 billion, with a growth of 21% year-over-year. Part of the increase was due to growing momentum across Adobe Lightroom from the state-of-the-art advancements in Adobe’s photography division. Creative mobile applications also saw good momentum and the company experienced strong customer acquisition in the quarter.

The Document Cloud segment generated revenue of $493 million, showing an increase of 31% from the second quarter of 2021. Adobe Acrobat Sign saw growing use, and Acrobat Web and PDF enjoyed positive trending performance as well. The company also saw higher customer acquisition from Acrobat, Scan, and Sign.

Adobe Experience Cloud generated revenue of $864 million based on subscriptions, with an increase of 29% from the third quarter of 2020. The company also witnessed increased adoption of Adobe Sensei, strong Workfront performance, higher product innovations, and higher customer acquisition.

As of September 3, 2021, the company’s cash and short-term investment balance was $6.2 billion, while cash flow from operating activities stood at $1.4 billion. The company also repurchased 1.7 million shares.

Adobe has provided guidance for the fourth fiscal quarter with total revenues of $4.07 billion and expects its year-over-year revenue growth from Digital Media and Digital Experience to be 20% and 22%, respectively.

Valuation Metrics

Adobe’s stock looks a bit expensive here as it is trading at 35.2x on an enterprise value-to-forward-EBITDA basis and 47.5x on a price-to-forward normalized earnings basis. In comparison, its five-year average EV/EBITDA ratio is about 26.3x, and its five-year average price to normalized earnings ratio is 35.9x.

Wall Street’s Take

From Wall Street analysts, Adobe earns a Strong Buy consensus rating based on 18 Buys and three Holds assigned in the past three months. The average Adobe price target of $720.16 implies 12.1% upside potential.

Summary and Conclusion

Adobe is a great company with a strong balance sheet and impressive performance momentum across its business segments. It has proven itself capable of establishing and growing strong brand power while continuously innovating to improve its competitive positioning. On top of that, Wall Street is overwhelmingly bullish on the stock right now.

That said, the stock’s valuation multiples look quite elevated compared to historical averages. As a result, investors might want to consider waiting for a pullback in the share price before adding shares.

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

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