Is Adobe Stock A Buy?

A shift from desktop to the cloud for its creative and digital document software franchises, adaptation of software-as-a-service (SaaS) subscription model and movement into high-growth areas makes Adobe a lucrative long-term investment prospect.

Adobe Inc. [NASDAQ: ADBE] is an American multinational computer software company, primarily known for its printing, publishing, and graphics software products. The company has recently forayed into digital media and digital marketing software.

Is Adobe Stock A Buy?

In the fiscal fourth quarter, Adobe reported EPS of $2.81, a growth of 23%. During the same quarter last year, the firm earned $2.29 EPS. The software company generated a record revenue of $3.42 billion for the quarter, up 14.4% from the same quarter in the prior year. Both revenue and profit topped expectations. 

Adobe’s performance continued its historic year, having delivered records in the first, second, and third quarters as well.

It is worth mentioning that Adobe stands shoulder to shoulder with far-larger rival Microsoft (MSFT) as, like the Windows OS developer, it, too, enjoys a stellar record of stable earnings growth.

Over the last three years, Adobe has reported an average annual EPS growth of 29%, while Microsoft, during the same period, posted average annual earnings growth of 20%.

The largest segment for the Silicon Valley-based company remains Digital Media, which generated $2.5 billion for the period, an upswing of 20%. The Creative side of this segment played the central role, bringing in $2.08 billion while the Document Cloud generated $411 million.

Annual Recurring Revenue (ARR) for the entire Digital Media component came in line with expectations of $10.18 billion. Cash flow from operations in the quarter stood at $1.78 billion, a new record for the firm.

Adobe Inc. also gave a stronger-than-expected annual revenue outlook, indicating the company’s belief in the highly popular Photoshop and other creative software applications to be primary engines of growth.

The company expects fiscal 2021 sales to be about $15.15 billion, above analysts’ expectations of $14.8 billion. Analysts expect EPS to grow 10% to $11.11 in all of fiscal 2021 and a further 17% in 2022.

The software giant expects revenue from its Digital Media division, including the creative and document clouds, to rise 19% in the next fiscal year, while sales of its marketing and advertising suite is also expected to record a 19% jump.

Focus on Big Data, AI and Machine Learning

Another major catalyst working in the company’s favor is its focus on new high-growth technologies.

The desktop publishing giant has been heavily concentrating on expanding the company’s “new” businesses, including its artificial intelligence, machine learning, and Big Data technologies.

In October, Adobe, Microsoft, and C3.ai, entered into a collaboration to integrate AI technology into customer relationship management (CRM). The partnership brings together Adobe Experience Cloud (which offers AI-driven solutions for marketing, analytics, advertising and commerce), Microsoft Dynamics 365 and C3.ai’s models to industry-specific, AI-enabled CRM solutions.

Additionally, Adobe’s approach to artificial intelligence and machine learning, Adobe Sensei (Japanese for “teacher” or “master”) allows marketers to discover meaning in data which, in turn, enables marketers and advertisers to make informed decisions for highly targeted and personalized marketing experiences.

Acquisition Of Workfront for $1.5 Billion

Adobe recently bought privately-held management platform specialist, Workfront, for $1.5 billion to add a collaboration tool to its marketing software to help marketers deliver more personalized campaigns. Workfront’s APIs permit a seamless connection to Adobe Creative Cloud and Adobe Experience Cloud. 

The two companies have been business partners going back many years, and currently share more than 1,000 clients, including Home Depot [HD], Under Armour [UAA], T-Mobile [TMUS], and Nordstrom [JWN], among others. 

Adobe hopes the addition, where Workfront’s platform will be added to Adobe’s Experience Cloud makes, will “further accelerate Adobe’s leadership in customer experience management, providing a pioneering solution that spans the entire lifecycle of digital experiences, from ideation to activation.” The deal is expected to close in Q1 of its fiscal 2021.

The company is also vigorously adding new creative software tools to keep the momentum going as far as its rapid revenue growth goes. The software maker, a couple of months ago, presented a version of its popular app, Illustrator, for Apple Inc.’s iPad, to ensure that its products are used on more devices.

It is worth mentioning that the revenue derived from the company’s marketing, advertising and analytics offerings were below expectations, which led Adobe to try extra hard to ensure that its crown in the design software market does not slip from its head. 

Share Buyback Program

As was the case with other big-tech firms, the pandemic benefitted the software company in a major way.

The company’s stock rallied in the wake of the “stay-at-home” economy but came off the highs as investors took their feet off the gas even as the company topped both, revenue and profit expectations, for the quarter ending November 30.

However, analysts expect the shares to climb again, courtesy its newly-announced share repurchase program.

The company is currently in the midst of a stock repurchase program worth $8 billion, expected to end at some point during the first half of 2021.

The graphics software developer recently announced a new $15 billion stock repurchase program to run through 2024, after the current one expires.

This should not come as a surprise though, as with more than $5 billion per year in operating cash flow, and around $6 billion in cash, Adobe has the wherewithal to indulge in such a hawkish buyback program.

The repurchase of stocks is expected to augment returns for the company’s stock in the coming years.

Risks Of Investing In Adobe

Adobe has generated incredible returns for investors over the past few years. However, it does not mean there are absolutely no risks associated with the stock.

High valuation coupled with high growth expectations can often lead to a situation where even the slightest of glitches can cause the stock to tumble. Rising competition and an outlandish valuation could possibly foment trouble for Adobe’s stock down the line.

Adobe has emerged as one of the leaders in the digital marketing industry, but faces intense competition in this segment. 

In the creative software business, its dominance is nonpareil, but the same can’t be said about the digital marketing business, where it has to compete with equally big names such as Salesforce.com, IBM (IBM), and Oracle (ORCL).

Adobe’s guidance for fiscal 2021 has been stronger than expected.  For the entire coming year, Adobe now guides revenue up to $15.15 billion, against the consensus estimate of $14.8 billion.  

The software company expects adjusted EPS of $11.20 for FY 2021, which is also above the consensus estimate.

There, however, could be a storm brewing if the company fails to deliver the kind of earnings growth it is projecting.  Adobe stock is riding on the promise of even larger revenue and profit growth ahead, but if something goes wrong for the company, and if the growth targets are missed, it could spell trouble for the stock.

More importantly, Adobe’s earnings may be soaring, but so is the share price. It is, no doubt, a high-flying growth stock, but investors should be mindful of the volatility that usually accompanies lofty valuations. Also, Adobe does not pay a dividend, which may dampen the spirits of dividend investors.

Are Adobe Competitors A Threat?

Adobe has 3 clouds:  Creative, Document and Marketing (Experience) Clouds. And Adobe has different competitors in these three segments.

Its bread and butter, though, is the company’s Creative Cloud segment, where Adobe still holds huge market share with top-notch brands such as Photoshop and Illustrator.

The Document segment consists of PDF and Sign. Adobe Sign is a part of the Adobe Document Cloud suite of services that lets you replace paper and ink signature processes with fully automated electronic signature workflows.

Here, too, the company is the market leader, though it faces some competition from few smaller e-signature tools out there like DocuSign [DOCU]. PDF, however, has a very low competitor number.

Marketing (Experience) cloud has plenty of big competitors eyeing the same customers as Adobe.  Salesforce.com [CRM], Oracle [ORCL], SAP [SAP] and IBM [IBM] are the big ones providing a subset of business functions in the digital marketing space.

There are a few like Magento rivals, including Shopify [SHOP] and BigCommerce [BIGC],that compete directly at an individual level.

Shopify had a stupendous 2019 while BigCommerce had a bumper IPO in August. Also, both Adobe and Salesforce face challenges from cloud communication platform Twilio (TWLO), which is challenging Adobe and Salesforce in digital marketing and customer engagement arena.

Adobe’s biggest competitor in the segment, Salesforce, recently announced its decision to buy the enterprise communications company, Slack [WORK], for about $27.7 billion.

Salesforce’s cloud-based customer relationship management service controlled 18 % of the global CRM market last year, while none of its rivals held double-digit shares. 

Salesforce’s business was further bolstered by the pandemic, as its revenue jumped 29% to $17.1 billion in fiscal 2020. 

While Salesforce’s main business is still customer relationship management, or CRM, it sees lucrative growth prospects in digital marketing business, as Salesforce leverages its dominant position in the CRM arena to tie companies to its advertising, marketing, e-commerce and analytics services.

Other large rivals of Adobe, such as Oracle and IBM, too, have the resources and the reach to capture a larger share in this growing market.

Having said that, Adobe is putting up a good fight here as well with a series of acquisitions. Adobe purchased Magento, a powerful e-commerce platform firm in June 2018 for $1.7 billion.

In the same year, it went on to purchase B2B marketing platform, Marketo, for $4.8 billion. And in December this year, it completed the purchase of work management platform, Workfront. The company is also not averse to tie-ups with bigger rivals such as IBM and Microsoft.

It entered into an alliance with IBM to run its software for the banking industry in IBM’s cloud system. And to compete more effectively with Salesforce, it allied with Microsoft on sales and marketing software. Adobe and Microsoft had either sales or marketing software whereas Salesforce offered both.

Is Adobe Stock A Buy: The Bottom Line

It has been a great year for Adobe as the creative software-maker got a subscriptions and earnings boost from people forced to stay at home because of the pandemic. However, it would be wrong to attribute Adobe’s stellar growth solely to the pandemic-induced digital services adoption.

The company’s revenue, under its long-time CEO Shantanu Narayen, who has been the chairman, president, and Chief Executive Officer (CEO) since December 2007, has been consistently growing over the years.

Narayen has played a pivotal role in Adobe’s expansion into cloud services, moving its creative and digital document software franchises – which include highly-popular names such as Photoshop and Acrobat/PDF – from the desktop to the cloud.

Another major achievement of Narayen has been the adaptation of a software-as-a-service (SaaS) subscription model for selling software.

A subscription-based business model enables Adobe to accumulate reliable, renewable revenue every month. The company has jettisoned its old licensing scheme, where you pay a one-time amount for the company’s software and use it forever.

Adobe has now in place a pay-as-you-go subscription scheme. And it has found favor with customers who seem to be happy to bear lower up-front software costs, even if the overall long-term expenses incurred are higher. 

Under the banners of Creative Cloud and Marketing Cloud products, these predictable and recurring revenues have solidified Adobe’s financial position. Despite the rise of mobile computing, the company looks more stable and profitable than ever, thanks to its robust suite of products across digital media and digital marketing.

Adobe stock has never been cheap, and investors have learnt to live with this fact. The stock, of late, has been witnessing some selling though, mainly because of unhinged expectations. The pandemic seems to have catapulted tech stocks to new altitudes with investors chasing them like starving lions after a herd of deer.

The delirium, to an extent, was reminiscent of the dot com bubble, the difference being that the companies this time are more legitimate. Adobe is over 10% below its highs, but still up 45% on the year. The dip in the price presents an opportunity for investors.  

Conclusion

Adobe is rapidly expanding into new and emerging areas, which puts it in a favorable position to take advantage of the opportunities present in the market.

The company has been quick to embrace change, and with the digital revolution taking off in a big way, Adobe qualifies as a long-term investment with solid earnings and revenue outlook for the time to come.

Addendum: Adobe 101

Adobe is best known for its Adobe Illustrator, a PostScript-based drawing package for artists, designers, and technical illustrators; Photoshop, a software for editing digitized photographic images; FrameMaker, designed for the production of technical manuals and book-length documents; and Acrobat Reader, which allows Internet users to view and print portable document format (PDF) files.

Other popular software products of the company are Adobe Flash web software ecosystem, Adobe Creative Suite, PageMaker, PageMill and SiteMill, to name a few.  The company operates through three segments: Digital Media, Digital Experience and Publishing.

Incorporated in Delaware and headquartered in San Jose, California, Adobe Inc. was founded in 1982 by John Warnock and Charles Geschke while they were employed at Xerox Corporation. When Xerox declined to bring the PostScript page description language developed by the founders, the duo formed their own company, naming it after the Adobe Creek in California, which ran near their homes.

In 1983, Apple Computer became the first licensee of PostScript. In 1985, Apple introduced the first Macintosh-compatible PostScript printer which brought into existence the desktop publishing industry. Adobe’s technology allowed any computer user to produce professional-looking electronic documents without any special training or equipment—a phenomenon that came to be known as desktop publishing.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.