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Executive Summary

Adobe, Inc. (NASDAQ:ADBE) specializes in the design and distribution of desktop publishing software--primarily under the "Creative Suite" or "CS" branding--to companies and individuals seeking such products (Source: Adobe, Inc.). The company's revenues continue to show consistent long-term growth, with minimal debt-related liability, thus demonstrating the company's ability to be virtually "self-sufficient" in regards to obtaining financial assistance for future endeavors. Though company operations are costly and, inevitably, have required debt-related financing activity, the company gains significant returns on sales, and therefore remains financially stable. Likewise, the company's demonstrated ability to repay financial obligations resulting from debt financing proves Adobe's returns on its projects funded by this method of financing greatly surpass the initial debt encountered.

The company continues to perform frequent acquisitions in order to acquire talent and other assets, in addition to that which Adobe produces itself. One of the most prominent of these acquisitions is the purchase of Macromedia in April 2005, which led to positive returns recorded on the 2006 financial statements. Likewise, Adobe continues to acquire talent, intellectual property, and other resources from various related firms in recent years, with multiple acquisitions documented in the 2012 annual report. As the company continues to develop new products, improve its existing offerings, and acquire complementary companies, the long-term success of the company is reinvigorated.

Certainly, investors' opinions of the stock are based, at least in large part, on the company's ability to continually demonstrate revenue growth. However, other factors affecting this outlook could include, hypothetically, stock sales by employees. As Adobe employees represent a significant portion of the company's shareholders, investors would likely become worried, should a large-scale selloff by either multiple employees, or a single influential employee with substantial holdings (such as the CEO or other executive) ignite investor unrest. Fortunately, this does not seem to be the current trend as of the time of writing. Likewise, future acquisitions could cause a similar effect. Though these acquisitions would, ideally, lead to future revenue increases in addition to those currently witnessed, Adobe would initially experience increased expenses in order to acquire the entity. As a result, investors could either take favorably or unfavorably to such news, and would certainly trade accordingly.

Similarly, the support and resistance levels, often acting as psychological barriers influencing investors to trade, could affect the market price of the stock. For instance, as of the time of writing, the Adobe stock price of approximately $45.00 currently contests that of the previous high in mid-2008 in the spectrum of the past five years. Effectively, Adobe is approaching the psychological resistance level, which may encourage some investors to sell their holdings in the company. Contrastingly, the support level-the level below which the stock rarely, if ever, falls-appears substantially lower: the lowest point the stock reached over the past five years remained slightly above $16.00 in early 2009.

Ultimately, though the stock is currently approaching a high point relative to the past five years, the projections contained herein suggest that the price per share should justifiably continue rising in the near future. Thus, the recommendation to buy the currently undervalued Adobe shares stands-though investors taking this approach may experience minor short-term fluctuations, the long-term horizon warrants a rise in the market price of ADBE.

Valuations, Ratios, and Measurements

Employing the company's financial statements for years 2008-2012, the following valuations and ratios were developed. Industry averages listed for price-earnings, price-to-book, price-to-sale, and price-to-cash flow ratios were each determined utilizing averages of individual company data obtained from SmartMoney for competitors in the same industry as Adobe.

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In each of the price-related ratios (price-earnings, price-to-book, et cetera), Adobe, on average, consistently performs near the industry averages. This indicates that, though the price of the individual common shares and company performance may fluctuate, Adobe consistently avoids consideration as "excessively overvalued," instead retaining a market per-share price that fairly accurately reflects the company's performance, directly correlating with company performance.

Additionally, the company's long-term debt per share, though increasing year-over-year, increases (relatively) proportionately with the company's sales per share. This indicates that, though the company certainly possesses debt--as do most companies in similar positions--Adobe is capable of fulfilling and, long-term, overcoming the debt it acquires through continued sales momentum.

Average Growth

The following table exhibits the average growth rates for Adobe between 2008 and 2012, derived from the previously mentioned financial statements. Values represent year-over-year percentage growth (e.g. 4.45% revenue growth from year 2011 to year 2012).

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Though the company encountered turmoil during the recent financial crisis--as exhibited by the negative values (decreases) in all metrics based on the 2009 financial statements--the performance of the company in later years greatly surpassed these decreases. As a result of recent acquisitions, purchases, and expansion, the company reported slightly negative net income and cash flow growth, though the dollar amounts of these changes continue to surpass the respective 2009 declines. Namely, revenue, earnings per share, and gross margin continue to demonstrate growth year-over-year.

Revenue Growth

The following table exhibits the yearly revenue growth over a ten-year period, separated by financial quarters. Revenues were obtained from the company's yearly Income Statements filed with the Securities and Exchange Commission, then divided by the revenues stated for the same quarter during the previous year (e.g. 2012 first-quarter revenue grew at a rate of 1.70% over first-quarter revenue of 2011).

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The growth rates for all four quarters in each year were averaged to generate an average growth rate for the year (e.g. an average revenue growth rate of 16.39% in 2012 over 2011). Next, these yearly average growth rates were utilized to generate an average yearly growth rate of 63.74%.

In an attempt to objectively classify individual years as "good" or "bad" in regards to performance, years significantly surpassing the 63.74% average were labeled "good," those at or very near the average labeled "average," and, finally, those performing substantially below the benchmark average were considered "bad," having demonstrated poor performance relative to the other years. The quarterly growth rates were divided by the size of the respective sample to determine the average growth during that type of year (e.g. "good" years-a total of 16 quarters-demonstrated an average revenue growth of 28.16%). These average growth rates were incorporated into the following pro forma financial statements to determine projections based on anticipated revenue changes.

Fundamental Analysis

Pro Forma Income Statement

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Pro Forma Balance Sheet

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Pro Forma Statement of Cash Flows

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Projections

Given the information from the above pro forma financial statements for each considered scenario of revenue growth, the following metrics were projected.

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As displayed in the above table, should Adobe's sales revenue increase by 28.16% (assuming 2013 would be considered "good" year based on the aforementioned criteria), the company would experience significant corresponding increases in operating margin, as well as returns on both assets and equity. As such, the company's potential increase in sales would generate a substantial amount of excess net income, which the company could utilize to fund additional projects, investments, acquisitions, or begin paying as dividends to shareholders.

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The above table exhibits per-share price estimates based on three criteria and the expected sales revenue growth rates, in an attempt to estimate the value of the stock. The data indicates that, given a forecasted sales revenue increase of 28.16% (recall, a "good" year for Adobe) would warrant a market price of between $52.79 and $65.93. Thus, in this scenario, if the stock currently trades for approximately $45.00 per share, the stock is undervalued, and the investor should purchase shares in the company. However, if the stock were instead selling upwards of $66.00, the investor should close his or her position in Adobe, as the stock is overvalued by the market.

The expected return column acts as a weighted average of the other three applicable columns for this set of data. As mentioned previously, the 28.16%, 14.80%, and -6.81% revenue growth estimates are not assured-any of the three scenarios could occur in the current year. Thus, if an investor believes Adobe will reach one of these estimates, he or she may assume the corresponding scenarios. Contrastingly, the expected return accounts for the relative likelihoods of each of the three revenue growth scenarios, providing an estimate of the stock price accounting for historical trends in yearly performance as to the likelihood the current year will exhibit a particular trend.

Sources

Relevant supporting financial documentation, such as year-end income statements, balance sheets, and statements of cash flows published by Adobe with the Securities and Exchange Commission for the years 2008-2012, may be obtained from the Adobe, Inc. Investor Relations website.

Source: Adobe Stock Valuation: The Case To Buy