Adobe has been a monster long-term winner for its investor's $10,000 invested in this
company at its ipo is currently worth more than $17 million.
Yet its stock is currently down more than 45% from a 52-week high here's why we think right
now is a great time to buy a few shares my name is Brian Feroldi and my name is Brian Stoffel
thanks to commonstock for sponsoring today's video as the time is recording i own shares of Adobe
and i do not so Brian despite being down nearly half of its all-time high adobe is still $172
billion dollar company Adobe's mission is to change the world through digital experiences
this is simple inspirational and optionable i love it i do too so how does the company do that well
it has a software as a service platform that focuses on three buckets let's dig into those
three buckets first is the adobe creative cloud these are the products that you are most likely
familiar with including photoshop illustrator adobe mirror lightroom and more the second is the
adobe experience cloud this aims to help marketers publishers advertisers and e-commerce companies to
do business this is a large and relatively new opportunity the totally addressable market is
almost double what the creative cloud is the third business segment is adobe's document
cloud this is a suite of tools that businesses and individuals can use to create and manage documents
the easiest way to think of this business is it's a direct competitor of docusign prior to 2012
adobe was primarily selling its software through one-time purchases but over the next five years
the company went through a transition where it wanted its customers to use the cloud by 2017 the
company forced all of its customers to make that transition to the cloud and its financials and
stock price have been flourishing ever since today it has a software as a service business model now
it doesn't offer net retention rates that we like to see with most companies like this but we do
know that annual recurring revenue is growing at a 16% pace which is a closest proxy we have for
that number adobe does have to spend to acquire new customers but its brand name is so strong and
so synonymous that its customer acquisition costs on an absolute basis are fairly low
the demand for its products seem to be resistant to the business cycle especially now that it's
gone through that cloud transition and the vast majority if not all this company's revenue is
recurring in nature but does the company have a moat yes it does now the first is the network
effect we think that this is relatively low in the past photoshop and other tools like it
were the industry standard and that meant that everybody had to use it because everybody else
was using it however there are other options today however we think this company's primary
mode comes from switching costs once you go through the arduous process of learning how
to use any of the company's tools it becomes a pain to switch away this is especially true for
businesses that use the company's experience cloud beyond that adobe definitely deserves credit for
its brand value it is top of mind for those in the industry and finally while the company has
plenty of competitors so far the company's numbers indicate that the moat is stable and perhaps even
expanding but what about financials when we look we see healthy growth revenue is up at about a 16%
clip over the past year and a half the gross margin sits near 90% and net income has been
positive for many years better yet the company pumps up more free cash flow than it does net
income its balance see is strong in absolute terms and returns on capital for this business are very
high but what about the company's leadership well co-founder dr john warnock was ceo and
chairman and still sits on the board today but the company is primarily run by shantanu narayan
the chairman and ceo who's been there for nearly 24 years employees give this company and ceo
and orion glowing reviews on glassdoor and while inside ownership is very low on a percentage basis
on a dollar basis it's more than $400 million that's some skin in the game now what about
optionality well the company has demonstrated that they've got it in spades it used to just
be focused on the creative cloud and the document and experience cloud are relatively new and even
within those tools there are many new tools that are rolled out to customers on the downside this
company is already so incredibly profitable that there isn't much room for operating leverage ahead
moreover the name has become so synonymous in its category that it's already captured
nearly 10 of its addressable market opportunity although that number continues to grow and the
company historically had been growing organically but in the last couple of years it's made some
sizeable acquisitions that have boosted its experience cloud investors can expect more
of acquisitions in the future well what about the stock itself brian mentioned at the beginning that
it has absolutely crushed the market since ipo but it's also beating the market over the last five
years and over the past year it's exceeded expectations three out of four quarters and met
in the other quarter the company is actively returning capital to shareholders primarily in the
form of buybacks while those buybacks have been offset by dilution due to share issuance through
shock-based compensation the number of shares outstanding has declined about eight percent over
the last eight years let's turn to risk first and foremost is competition with three different cloud
products each one has its own set of competitors docusign for the document cloud companies like
figma for the creative cloud and salesforce and many other big names in the experience cloud
beyond that we don't see a lot of business risk we do see a little bit of valuation risk more on
that in a little bit let's check in with how the company did in their fiscal second quarter which
they just reported revenue grew 16 percent and it beat both analysts and management's expectations
it was a similar story on the bottom line with adjusted earnings per share growing 11 percent
which also beat wall street's estimates the company's margins were roughly in line with
their historical precedent with gross margins of near 90 and healthy operating in net margins
free cash flow production and net income remained strong and the balance sheet remains in good shape
now where the stock ran into trouble was guidance versus expectations management said that the
revenue should grow about 14 which was below wall street's estimates and it was the same story on
the bottom line with growth slower than what the market was hoping for it was a similar story for
the full year management is guiding for 12 growth and 8 growth in the bottom line those figures were
slightly behind what wall street was expecting so what are we going to watch moving forward
is shareholders well first is annual recurring revenue this is a great proxy for how strong the
business is and how much it's growing second thing to watch is remaining performance obligations this
is a indicator of future demand we want to see this number continue to grow third we're going
to pay special attention to the experience cloud remember the total addressable market is nearly
double the creative cloud and there's a lot of opportunity there fourth we're going to keep
an eye on margins specifically profit margins this is a company that is already optimized for profits
and has made the cloud transition we expect those profit margins to remain high indefinitely overall
we believe that worst case scenario the moat is stable but probably widening and the thesis is on
track we recently ran adobe through our investing checklist and the score remained fantastic this
company got an 85 on my investing checklist which puts it into the high quality business category
and it got an 11 and a half on my framework which makes me wonder why i didn't already own this
in terms of where adobe is in its business cycle we believe it's clearly in the maturity
phase it's still growing its top line at a double-digit rate but this company is optimized
for profitability for that reason the price to earnings ratio and the price to free cash flow
are useful metrics for judging this company's value now as a reminder when we look at valuation
we need to remember the transition in the business model the company went through if you look back
historically at this company's revenue growth it did remain strong however it did decline during
the great recession of 2008. the second big decline came when the company decided to make
the transition to the cloud if you're confused as to why that happened we recently made a video on
uipath which is going through a similar phenomenon right now so when we look at the price to sales
ratio of 10 that is high on an absolute basis however it's lower than it's been in a number
of years and about in line with where it was when it was going through that transition if you look
at gross profit this figure has remained high but it's skyrocketed in recent years that is in part
due to the transition to a cloud and also the move into the experience cloud due to some acquisitions
if we take that gross profit number divided by the market cap we see that it's trading for about 12
times gross profit that's high compared to the rest of the market but historically for adobe
not terrible on a price to free cash flow basis adobe is currently trading at about 25 times free
cash flow that's the lowest rate since it made that cloud transition although it's still high
on a historic basis it's the same story when we look at the price to earnings ratio trading at
35 times trailing earnings adobe is expensive compared to the market though it's the cheapest
since it went through its transition and while we don't have a lot of long-term data to look at when
judging this company on a forward p e ratio it is trading at the lowest forward p e ratio on record
so there you have it we're going to be buying $250 worth of adobe and you can follow along
on common stock where our portfolio is there for the public to see we're going to be posting all
the slides that you see in this presentation over on common stock and we would encourage you to go
there and push back against anything that we've said common stock has agreed to pay $250 dollars
to the comment that we deem the most insightful and we want to give a shout out to steve matt for
winning that award for his comment about our purchase of proximity common stock sent steve
$250 and if you want to be eligible to receive $250 cash payment head on over common stock leave
a comment in our portfolio and you'll be entered in the contest overall brian and i think that
adobe is an extremely high quality business that's trading at a relatively attractive valuation while
there's no telling where this stock might head in the short term we believe that the long term
project of this business will be up we hope that you found this video to be useful brian's out