I was just chatting on our Discord today, and I reminded myself to look at this "boomer stock"... which I don't think is a boomer play at all. It's a great, quality company... and after dropping 25% from its highs, it's worth diving deeper. The question is, "is it time to buy yet?".
Btw, we just started the Discord channel, which I know will grow into a great community of no-hype investors (like myself)... but now would be a great chance to join and be part of a more intimate community (and yeah, it's free).
Business Model & History
This company is an OG. It's been around for time! It's gone through a lot, evolved, and it's battled tested through the years. It's definitely on the more defensive side of tech.
Adobe has three major segments of business – Digital Media, Digital Experience, and Publishing and Advertising. However, they also report in more broader segments of Subscription, Product, and Services. We'll use the latter to form our valuation, which you'll see below.
Digital Media, which is the bulk of their business (>70%), is primarily recurring, and profitable. It's the segment that has the household software that you're probably most familiar with – Photoshop, Lightroom, Illustrator, Acrobat, Premier Pro, After Effects, Dreamweaver. These are not only household software, but also for professional user. In fact, I'd imagine most of their business is B2B, whether it be small or large.
Digital Experience, is the second largest segment, but still relatively small is suite for Analytics, Content & Commerce. It's not as large, nor is it growing as fast as the Media segment – which makes sense.
Publishing & Advertising
Finally, we have Publishing & Advertising – the smallest segment – which appears to include what I'd call some stagnant software.
But, that's pretty much it... it's not a super complicated business. It's quite easy to understand and come up with our valuation.
The valuation spreadsheets are available to premium members of The Hawk Letter and Discord group. So, make sure you join so you don't miss out!
Although the pandemic had boosted many tech stocks, it's hard to say that Adobe was a clear beneficiary. I'm sure they also had cancellations because of small businesses cutting costs, etc. With revenues up 16% in 2020 and 25% in 2021, it doesn't scream pandemic winner... because 2019 was also up 26%. They've had 20%+ growth since 2016. Most of the growth, as mentioned, was in the Subscriptions or Cloud (i.e. Digital Media + Document) segment.
They have 40% operating and 30% net margins, which screams out at the quality of this company.
The concern, here, is future growth. If I hadn't seen their 2022 guidance, I would have been a lot more bullish. And, that's what I think any analyst had out there... which is why the stock dropped 30%. So, I'm going to take the more conservative approach and assume a significant slowdown in growth immediately, aligned with their guidance for 2022, with $17.9B in revenues.
My DCF, which again, is more conservative, tells me Adobe is fairly valued. However, every analyst and model out there is more bullish – probably because their models are not factoring in a slowdown in growth.
Based on this, I would say Adobe is fairly valued. It's not necessarily undervalued. But when you compare it's valuations to its peers like, Intuit, for example, it's more attractive. But, this software segment as a whole is getting shot – Salesforce, DocuSign, etc – however, I would say that no matter where you look, it's hard to say there's better quality than Adobe.
I wouldn't say Adobe has any risk of competition. It has one of the strongest moat in the tech, and especially software, industry. The real risk, to its stock price, is the macro factors like rising rates and tightening liquidity.
So, to understand that, we'd have to look at historic P/E ratios and where Adobe trades. Before the pandemic, Adobe was at a 50 P/E... kind of where it is now. But, at the time, it had higher growth expectations, which it did achieve.
So, here's my conclusion...
Adobe has been shot down to pre-pandemic valuations. It's looking attractive. It's no doubt one of the strongest and most defensive tech plays. It's a company that any portfolio can have exposure too, and it would make sense.
That being said, the wild card, is the future growth. What do you think it will be? Did Adobe management sandbag their 2022 outlook? Those are the main questions as to whether you buy the stock now, or you wait to have a higher margin of safety.
How will Adobe Creative Cloud and Document Cloud play into the future? I hate to say this, but will Creative Cloud play a role in the metaverse (lol)? Probably. Metaverse or not, it's at the core of the growth of many trends we're going to be moving towards. But, still, in this market, I need some margin of safety and I'll always chase some alpha.
So, when would I (personally) enter? Closer to a 40x P/E is where I would start, which is closer to $420 – which is another 19% drop. Don't get me wrong... I like the company, but it's still an expensive stock. I'm not dying to be in the name, because there isn't a clear sign of growth. Microsoft is trading at a 35x P/E, which I would say is the closest comparison. Give me something closer to that valuation and I'll take it!
As always, I don't want to spend too much time on a stock that I'm not buying to be conscious of both of our times. If you think I'm missing something, or want to add something, I'm always happy to discuss. Join the Discord... let's talk!
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