Quality Comes with Expensive Price By TipRanks

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© Reuters. Adobe Stock: Quality Comes with Expensive Price

Adobe (NASDAQ:) is imposing itself on the future of digital media and digital marketing, with the company essentially monopolizing its industry.

Adobe has gracefully leveraged the benefits of its recurring SaaS revenue model, providing its software and tools through a monthly subscription. Its suite incorporates the most advanced and comprehensive tools in its field, including software like Photoshop, Illustrator, and After Effects, which are widely regarded as must-haves for effectively any type of digital creator. (See ADBE stock charts on TipRanks)

Moreover, because creators are automatically subscribed to the whole suite, they usually don’t bother and/or need to search for any substitutes. Consequently, Adobe enjoys a fantastic moat in its industry, practically leaving no room for competition to emerge.

However, despite Adobe’s moat and overall qualities, the stock’s pricey valuation is likely to limit its future upside. I am bullish on the stock, but Adobe is certainly not cheap.

Unstoppable Growth Momentum

Adobe released its Q2 results in June, delivering another quarter of exceptional growth in both its top and bottom lines.

Revenues were $3.84 billion, indicating 22.7% year-over-year growth, powered by a growing global customer base that keeps showing phenomenal momentum.

Particularly, Adobe’s Digital Media division (which involves the company’s flagship software, and is its most prominent revenue contributor) posted revenue growth of 25% year-over-year to $2.8 billion. In fact, it added new annualized recurring revenue (ARR) of $518 million, advancing ARR to $11.21 billion, a new record.

Accompanied by a solid performance in its Digital Experience and Publishing/Advertising segments, Q2’s results launched Adobe’s LTM (Last-Twelve-Month) top line to a new all-time high of $14.4 billion. To highlight the strength of Adobe’s momentum, its LTM revenues have now breached new highs for 29 sequential quarters.

Valuation, Capital Returns

Subsequent to Adobe’s latest results, the stock has continuously rallied to new all-time highs, reaching $673.88 on September 3.

Management provided its Q3 outlook, expecting revenue growth of around 22% to $3.88 billion, and GAAP EPS of around $2.27. Combined with the results posted in the first half of the year, analysts estimate FY2021 EPS of around $12.25.

On the one hand, Adobe’s results were once again impressive. On the other hand, shares have rallied disproportionally higher than Adobe’s financial growth, leading to a worrying valuation expansion.

The stock is currently trading with a forward P/E of 51.2, which is considerably higher than its historical average of around 33. Considering that revenue growth should remain robust, but not supernaturally accelerated, one could argue that the stock is overvalued.

Further, Adobe’s ability to return cash to shareholders has also been somewhat limited at its current valuation multiple. Since Adobe utilizes stock buybacks as its only capital return method, the company is essentially now “overpaying” to repurchase its own stock.

Wall Street’s Take

Turning to Wall Street, Adobe has a Strong Buy consensus rating, based on 18 Buys, two Holds, and zero Sells assigned in the past three months. At $661, the average ADBE price target implies 2.6% upside.

Bottom Line

Overall, Adobe is without a doubt a fantastic company, with a wide moat and excellent growth prospects ahead as the digital economy continues to grow.

However, the stock certainly comes at a premium price. I am bullish on the stock for its long-term potential, though Adobe is by no means attractively priced.

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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