What's going on guys? Nick here, back with another video!
Adobe is a company and a stock that I've never really bothered to give much consideration to. But
the other day, I pulled up the income statement, and I was really impressed by what I found.
But recently, the stock price has experienced a pretty steep selloff after trading sideways for
about 6 months. So I thought I would go through Adobe's business and explain how it works,
how well are they doing financially? And if now would be a good time to buy shares?
In 2013 Adobe made a huge, and very important change to their entire business model. They
announced the Adobe Creative Cloud would replace the Creative Suite. If you arent
familiar with these, the creative suite is Adobes collection of creative programs, like photoshop,
premiere, and lightworks. The creative cloud would still have
all of the same programs as the creative suite, so nothing was going away. Instead,
the big change was transitioning from a one-time upfront fee to a subscription-based model. They
made this change to address major issues nagging Adobe and their business model.
The first problem was having to charge a large fee to their customers for their products.
It was difficult for many customers to spend $700 to buy Photoshop CS 6,
the final version under the old creative suite model. Or to buy the entire creative suite for
somewhere between $1,300 to $2,600 depending on the exact version you picked. This huge price
tag meant there was a lot of pressure on Adobe to make the new version worth the upgrade. If
there wasn't enough of an improvement, customers wouldn't have a reason to update. Once customers
purchased the new software, Adobe would have to support these software versions for years.
Even as they became dated and weren't getting any additional revenue to fund the support.
So this is why in 2013 adobe announced it was going to move
from the Creative suite, to the creative cloud.
Currently, with the subscription model, you can get access to the entire creative
cloud for $53 a month when you commit to a year, or $10-21 a month for single apps.
For customers, this meant they no longer had to make those huge upfront lump payments to
get access to the apps. Or worry about whether or not the new version would be
worth the cost to upgrade. And as long as you keep paying the $10 to 20 to 53 dollar payments,
you would always have the most up-to-date version. You also wouldn't have to worry about anybody
else you're working with using an older or newer version, which means no more compatibility issues.
While $53 a month for the full creative cloud adds up to a lot,
$636 a year, it would take 4 years to match the $2,600 cost of the old creative cloud.
And on top of that, again, you always have the most up to date version of the app.
So unless you were waiting more than 4 years to upgrade it should actually save money.
Now for Adobe, this meant that they could release updates as they were made,
continuously keeping the customer happy with new improvements. And they wouldn't have to
deal with providing support for outdated versions of programs they weren't getting
revenues for anymore. Later on, we'll take a look at how this changed Adobe's financial position.
So Adobe breaks itself down in to three segments, Digital Media,
Digital Experience, and Publishing and Advertising. The focus though,
is on the Digital Media, and Digital Experience business. Adobe says the third segment,
the Publishing, and Advertising segment, contains some of their legacy products.
The Digital media business is the Adobe creative cloud. These are all of their creative products
like photoshop, premier, Lightroom, InDesign, After Effects, and Acrobat.
The digital experience business is the adobe experience cloud. It's enterprise software
combining marketing, advertising, customer analytics, and commerce together under the
Adobe Experience Cloud. Compared to their Media Cloud, this is a much newer segment. They compete
against other enterprise marketing business-like, Salesforce. However,
Adobe has a slightly larger market because they're also involved in
executing ad purchases, a $20B market. Adobe estimated in 2019, the entire available market
for their Experience cloud business is $53B, and growing at 34% per year.
Because the Creative cloud generates a significant free cash flow,
Adobe has been able to use some of this cash to build out their Experience cloud. The majority
of customers using the creative cloud are creators and not necessarily business owners
who need enterprise software. Adobe has made some acquisitions to strengthen the Experience cloud,
including buying Marketo, a work management platform for marketers. And market - a marketing
engagement platform for $4.7B in 2018. Magneto, an e-commerce shopping platform for $1.6B in 2018.
So let's take a look at how Adobe's business is actually performing.
Looking at revenue, operating income, we can clearly the difference after switching to the
subscription model has made. Again, 2013 was the year they made the big switch to the creative
cloud. And on this graph, we can really just how well it's paid off for the business. Growth from
2006 to 2012 was pretty mild, especially compared to 2013 on. What also really sticks out to me,
is the massive profit margins they're making. Over the past 12 months, Adobe reported 40%
profit margins, with just over $5B net income on $12B of revenue.
Looking at their expenses compared with revenue, we can see why they're able to
end up with such a high-profit margin. Their cost of revenue has remaining very consistent
even as revenue has grown. Sales and marketing are their biggest expenses, much more than the
cost to produce their own products. When the cost of revenue is low, this usually will allow the
company to have much better margins, especially if the company does well in their market.
When we look at their segments,
digital media is the biggest segment and also incredibly profitable with a consistent 96%
gross margin. We don't always see companies this large still growing their largest segment,
so to me, this stands out as a very strong sign for their growth going forward. Digital experience
still maintains a very impressive 62-67% gross profit and shows steady growth.
Their balance sheet shows $24B in assets to $11B in liabilities. This gives us $24B
in equity. They reported $4B in debt, so they have a debt to equity ratio of .16,
a very healthy number. They also reported $4.4B of cash. Overall, this is a very
healthy company which we would expect with the massive profit margins they're achieving.
Ok, so let's take a look at what Adobe stock is worth.
But before I do that, if you've found this video helpful, make sure you hit the
like button! These videos take a pretty good amount of time and research to put together,
so if you could help me out with a quick thumbs up I would really appreciate it!
So looking at the forecasted earnings, Adobe is projected to continue its growth going forward,
with an estimated $20B in revenue in 2023, and $7.3B in profits. They're also still projected
to retain their roughly 40% profit margins. When we look at this in terms of revenue growth,
since the switch to the subscription model, they were able to achieve just over 20% growth from
2016 to 2019. 2020 did see some slow down with only 15% growth. Currently, analysts project
the end of 2021 to show 18% growth, but then they're expecting some decay going forward.
I wonder if we really will see this growth fall off that's currently being forecasted.
It would seem to me if Adobe's forecasted 2019 total available market of $53B
and annual growth of 34% is accurate, I would expect them to maintain more than 12%.
So for this valuation, I'm going to use a top-end growth rate of 14%,
just a little above the 2023 forecasted growth rate. For the bottom end valuation, I'll use a 10%
growth rate, just below the forecasted forward growth. This comes out to a fair P/E of 22 to 32.
2020 finished the full-year earnings $10.83 per share. This gives us a valuation between $247
to $360. If we look forward to 2021, they're currently forecasted to earn $13.26 per share,
which gives us a valuation between $292 to $424. For 2022
analysts see $15.43 per share. This would bring the valuation up to $339 to $493,
putting the current share price right in the middle of these two numbers.
Looking at this on a chart, we can see visually how this works out. With the top end earnings
multiple 32, this would hit fair value sometime between 2021 and 2022. And for the bottom end,
the share price wouldn't be supported by the fundamentals until between 2024 and 2025.
If we look at macrotrends.net, we can see how the PE ratio has changed over time.
Since 2016 forward, they've basically traded at a P/E of 50. When placed in my P/E reverser formula,
this gives us an implied expected growth rate of 19%. Which makes a lot of sense when we look again
at the growth rate. We can see as Adobe's revenue growth has decreased, the earnings multiple
has come down a little. The current P/E of 41 would mean an implied earnings growth rate of 16%.
So if we look at this on a chart, we see a pretty similar trend with a lot of the other tech giants.
It's basically traded flat for the past 6 months, and then dropped off with the recent sell-off.
It seems like we did see a little bit of a volume spike during the dip initially, but
that's trailed off. This would indicate that there may not be as much momentum to send this stock
right back up to the high 400's like it had been trading. It seems, looking at the RSI and MACD,
the sell-off momentum has slowed down, and the stock is recovering from being oversold.
So looking at Adobe stock, if you're considering buying. The fundamentals are very strong for
this company, but growth is expected to slow a little over the next few years.
I think it's a reasonable price if you're looking to buy, but I think this also depends on what type
of return you're expecting to get. I don't see the earnings supporting the current stock price
for at least another year, but this looks like a very strong company with steady growth going
forward. I really see a lot of good in this stock long term. Earnings are forecasted to
come out a week after I release this video, so some of this may slightly change after that.
What you need to consider, is if their forward growth is enough for what you're looking for?
I personally don't own any Adobe stock, and the only reason I'm not buying any right now is I'm
just looking for a little more growth or to buy at a much lower price than what I currently think
they're worth. That's just me though, everybody else has different goals and risk tolerances.
If you want to learn a little more about my process for researching stocks, I actually made
a video explaining the exact steps that I take a couple weeks ago. It's all very easy to follow
regardless of how much experience you already have, and I highly recommend checking it out.