At $500, Adobe Is a Fine Buy and Hold Software Investment - Investorplace.com
Tech stocks keeping going up and up. It's been a thrilling ride to be certain. But it can create a sense of stress. With tech stocks already up so much, what's left to buy at a reasonable price? Don't despair though — there are still some good choices. For one such option, consider Adobe (NASDAQ:ADBE) stock.
Adobe is a leading software name focusing on graphics, video, and other such content. The company's flagship Photoshop product is iconic. However, investors might not realize how much Adobe's business has evolved over the years. They don't just rely on selling a new upgrade of Photoshop every few years. In fact, Adobe's clever business pivot is why shares are still attractive now.
A Highly Successful Subscription Model
It's not a secret that Wall Street loves recurring revenue. Sell something once, and your stock will get a fairly modest valuation. However, if you can get subscription revenue, investors will pay a far higher price for a company. Seems obvious what to do then, right?
In practice, however, many companies have tripped up trying to switch from a software sales to a subscription model. Adobe originally faced a similar slowdown as its end customers balked at signing up for subscriptions. Quietly though, Adobe has now built a powerhouse.
Instead of selling $1,000 Photoshop licenses, Adobe's creative cloud — now exclusively available via subscription — comes at far more accessible price points. And it's bundled. In addition to Photoshop, this cloud includes Illustrator and various other pieces of software integral for users working in media, graphic design, video creation, and so on.
The company has managed similar success turning Acrobat into a big business as well. That's with the document cloud that bundles Acrobat in with various other storage, security, and file transferring services. Users have some limited access for free but have to upgrade to unlock the full-featured suite.
The document cloud in particular is having a fantastic 2020. With few people working from offices at the moment, document security and remote signature services have never been more important. There's competition in this field. But with Adobe already having so many customers for its other services, the company is having tremendous success cross-selling products.
Valuation: Not Too Crazy
ADBE stock is selling at 48x 2020 earnings, which at first glance might seem expensive. However, if you actually look at most cloud software companies, they are barely profitable or outright lose money. And Adobe's profit growth (not revenue growth, but actual profits) is strong. Analysts see 15% or so annual growth going forward. This would lift EPS to more than $13/share in 2022, causing shares to trade at 35x earnings.
That's not cheap, exactly. But it's not at all outlandish in a world where interest rates are zero and high-quality stocks are priced at ambitious valuations. Similarly, ADBE stock is selling at 18x revenues which again isn't a bargain but it's better than its median cloud stock peer. For such a strong brand with persistent growth and high levels of profitability, you can easily justify this price for Adobe stock.
Bears can argue that Adobe isn't worth that much of a premium. And that's a valid concern. For a data point, look at SAP (NYSE:SAP). The German software giant got shellacked for a 23% one-day decline Monday after a massive guidance cut. SAP was trading at 35x earnings before the stock plunged Monday. Thus, if Adobe's growth slowed precipitously — like SAP — at a mid-40s P/E ratio, it would be vulnerable to a similar correction. However, SAP is heavily tied to travel and leisure-related industry, whereas Adobe's product offerings fare better in a work-from-home world.
ADBE Stock Verdict
There are very few software stocks trading at an outright cheap valuation right now. And Adobe isn't cheap either. However, unlike many software stocks, Adobe is strongly profitable and has a nearly unchallenged position. It's hard to imagine how another software company could realistically topple the Adobe Creative Cloud in the near future.
This makes Adobe's stock far more appealing than people might realize at first glance. For example, compare Adobe to Zoom Video (NASDAQ:ZM). Zoom is selling for 650x earnings and 110x sales. Adobe is at 50x and 16x respectively, by comparison. And sure, while Zoom is growing faster now, its long-term position is far less certain.
A ton of high-quality companies have viable video alternatives to Zoom's flagship product. Whereas, there's almost nothing on the same level as Adobe. Photoshop, Acrobat, and other leading Adobe products will still be industry standards in five or ten years. Adobe may be less exciting than some of its peers since Adobe's products aren't a hot new thing. But their relevance is as high as ever, particularly in a work-from-home environment. As far as software stocks go, Adobe is about as compelling as they get right now.
On the date of publication, Ian Bezek did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek.
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