The Bottom Fishing Club: Adobe

Sep. 17, 2022 7:58 AM ETAdobe Inc. (ADBE)AAPL, ADSK, CDNS, CRM, DOCU, INTU, MSFT, TEAM, WDAY54 Comments
Paul Franke profile picture
Paul Franke
18K Followers

Summary

  • Investors should view the temporary (yet meaningful) setback in Adobe's share quote this week as a gift for new buying.
  • The -20% price tank on news of the Figma acquisition looks to be an exaggerated emotional reaction, inside a Wall Street bear market.
  • A high and rising free cash flow yield of roughly 5% is worth the price of admission for long-term holders.

Adobe home page

SeanShot

A year ago in July here, I made the valuation call Adobe (NASDAQ:ADBE) was too expensive at $625 per share, and would likely trade 30% lower into 2022. Well, the Big Tech bust from extreme overvaluations late in 2021 has arrived. With rising interest rates affecting what investors are willing to pay for a company and now a slowing economy dragging down almost every software company in price, including Adobe, it has become abundantly clear valuations do still matter.

Seeking Alpha - Paul Franke, Adobe Article July 2021

Seeking Alpha - Paul Franke, Adobe Article July 2021

What I didn't foresee was a debatable management decision to spend $20 billion in cash and stock on an acquisition of online design company Figma, announced September 14th. While it may take a few years to measure for sure if this takeover idea was a good one (I could argue either way), the initial investor reaction has been to club the stock price to death. Over the last several trading days, the quote has dropped -20%, for a total market cap drop of $35 billion (almost double the purchase value of Figma).

www.figma.com Homepage - September 16th, 2022

Figma Company Homepage - September 16th, 2022

So, here's my bullish valuation argument, the opposite of last year's sell article. Adobe's valuation has imploded from a record high in November 2021 around $700 per share to between a 6-year and 9-year low at $294 per share currently. The business is still extremely profitable, marketing an enviable lineup of online subscription products (SaaS), while the new asset acquisition will only drag down per share results in a very minor fashion for a few years. If you are looking for Big Tech exposure from the PDF file format creator, selling must-have graphic design programs to businesses and consumers, now is a great time to contemplate adding Adobe to your portfolio.

Desirable High-Margin Business Model

The new Figma business with scant sales and earnings vs. the purchase price (but growing rapidly, holding quite complimentary software with Adobe) will not negatively affect overall profit margins, while reducing EPS by about 5% in 2023-24, by my calculations. You have to ask yourself if a 5% short-term downgrade to earnings potential deserves a 20% hit to the stock quote? My answer is absolutely not, all other variables remaining the same.

According to the company, Figma is expected to add approximately $200 million in net new [Annual Recurring Revenue] ARR this year, surpassing $400 million in total ARR exiting 2022. Figma sports best-in-class net dollar retention of greater than 150%, with gross margins of approximately 90% and positive operating cash flow. For buyout logic, the idea is a merger with Adobe's product offerings will allow Figma's millions of users to mushroom into tens of millions over the next 3-5 years.

YCharts, ADBE Profit Margins - 10 Years

YCharts, ADBE Profit Margins - 10 Years

Adobe's gross and final profit margins are some of the highest of any blue-chip company in America, including other Big Tech firms. Adobe is nearly the top performer on margins compared to application software peers and competitors like Microsoft (MSFT), Apple (AAPL), Salesforce (CRM), Intuit (INTU), DocuSign (DOCU), Cadence Design (CDNS), Autodesk (ADSK), Workday (WDAY), and Atlassian PLC (TEAM).

YCharts, ADBE vs. Peer Software Companies - Profit Margins Past 12 Months

YCharts, ADBE vs. Peer Software Companies - Profit Margins Past 12 Months

More good news, before the Figma headline and herd downgrade rush, analysts were projecting strong and steady EPS growth, similar to the leading software names as alternative investment choices.

YCharts, ADBE vs. Peer Software Companies - Projected EPS Growth to 2025

YCharts, ADBE vs. Peer Software Companies - Projected EPS Growth to 2025

Lowered Valuation Worth Owning

In my experience, if you can buy a popular brand-name company on a steep price drop, technology related or not, it usually turns out to be a terrific opportunity for long-term capital allocation. In addition, buying a high-margin business with a P/E ratio closer to underlying growth rates (PEG analysis) is often a uniquely profitable proposition. With Adobe, you get both under $300 a share in September.

Free cash flow yield is approaching 5% (before Figma is thrown into the mix, when the deal is closed next year), which is the top spot in the major company, software sector. This number may be the best argument to get serious about an Adobe stake.

YCharts, ADBE vs. Peer Software Companies, Free Cash Flow Yields - Past 12 Months

YCharts, ADBE vs. Peer Software Companies, Free Cash Flow Yields - Past 12 Months

Looking at trailing 10-year ratio analysis of basic operating fundamentals, the valuation story has become compelling quickly in late 2022. On price to trailing earnings, sales, cash flow, free cash flow, and book value, Adobe is the least expensive for buyers since 2013-16, depending on which number you are researching.

YCharts, ADBE Price to Fundamental Ratios - 10 Years

YCharts, ADBE Price to Fundamental Ratios - 10 Years

Taking into account balance sheet items like debt and cash, enterprise value calculations are just as cheap. EV to revenue is back to 2014 average levels. And, EV to EBITDA (earnings before interest, taxes, depreciation and amortization) is the same as 2013, a good nine years ago.

YCharts, ADBE EV to Revenues - 10 Years

YCharts, ADBE EV to Revenues - 10 Years

YCharts, ADBE EV to EBITDA 10 years

YCharts, ADBE EV to EBITDA - 10 Years

Final Thoughts

I am upgrading my Adobe rating to Buy. The stock represents a solid pick, with growth-at-a-reasonable price [GARP] characteristics. An equity price approaching the worst days of the COVID-19 pandemic shutdown in March-April 2022 is quite absurd. On the 3-year chart of daily changes below, you can review the bullish trend in a variety of momentum indicators over the last two and a half years.

StockCharts.com, ADBE - 3 Years of Daily Changes

StockCharts.com, ADBE - 3 Years of Daily Changes

I do not expect price to become much cheaper, even during a deep recession. The biggest risk is more immediate, the continued zigzag lower by Wall Street equities in general. However, if Adobe's quote does fall another 10% to 20%, I would consider such as Strong Buy territory.

For now, opening a starter position, with an eye toward increasing your stake into early 2023 is a smart accumulation plan. A 5% free cash flow yield is much stronger than recent years for Adobe, yet remains a sizable distance from the prevailing 8%+ CPI inflation rate. In a bullish change of events (let's hope), declining inflation rates under 4% by next summer could support a respectable +20% to +30% increase in Adobe's quote. Nothing spectacular, but this projected increase will likely best a stock market churning its wheels, getting used to a slower economy with flatlining business growth rates.

Thanks for reading. Please consider this article a first step in your due diligence process. Consulting with a registered and experienced investment advisor is recommended before making any trade.

This article was written by

Paul Franke profile picture
18K Followers
Nationally ranked stock picker for 30 years. Victory Formation and Bottom Fishing Club quant-sort pioneer.....Paul Franke is a private investor and speculator with 36 years of trading experience. Mr. Franke was Editor and Publisher of the Maverick Investor® newsletter during the 1990s, widely quoted by CNBC®, Barron’s®, the Washington Post® and Investor’s Business Daily®. Paul was consistently ranked among top investment advisors nationally for stock market and commodity macro views by Timer Digest® during the 1990s. Mr. Franke was ranked #1 in the Motley Fool® CAPS stock picking contest during parts of 2008 and 2009, out of 60,000+ portfolios. Mr. Franke was Director of Research at Quantemonics Investing® from 2010-13, running several model portfolios on the Covestor.com mirror platform (including the least volatile, lowest beta, fully-invested equity portfolio on the site). As of August 2022, he was ranked in the Top 5% of bloggers by TipRanks® for stock picking performance on positions held one year. A contrarian stock picking style, along with daily algorithm analysis of fundamental and technical data have been developed into a system for finding stocks, named the “Victory Formation.” Supply/demand imbalances signaled by specific stock price and volume movements are a critical part of this formula for success. Mr. Franke suggests investors use 10% or 20% stop-loss levels on individual choices and a diversified approach of owning at least 50 well-positioned favorites to achieve regular stock market outperformance. The short sale of securities in overvalued, weak momentum stocks as pair trades and hedges is also a part of the Victory Formation long/short portfolio design. "Bottom Fishing Club" articles focus on deep-value candidates or stocks experiencing a major reversal in technical momentum to the upside. "Volume Breakout Report" articles discuss positive trend changes backed by strong price and volume trading action.

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, but may initiate a beneficial Long position through a purchase of the stock, or the purchase of call options or similar derivatives in ADBE over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This writing is for educational and informational purposes only. All opinions expressed herein are not investment recommendations, and are not meant to be relied upon in investment decisions. The author is not acting in an investment advisor capacity and is not a registered investment advisor. The author recommends investors consult a qualified investment advisor before making any trade. Any projections, market outlooks or estimates herein are forward looking statements and are based upon certain assumptions and should not be construed to be indicative of actual events that will occur. This article is not an investment research report, but an opinion written at a point in time. The author's opinions expressed herein address only a small cross-section of data related to an investment in securities mentioned. Any analysis presented is based on incomplete information, and is limited in scope and accuracy. The information and data in this article are obtained from sources believed to be reliable, but their accuracy and completeness are not guaranteed. The author expressly disclaims all liability for errors and omissions in the service and for the use or interpretation by others of information contained herein. Any and all opinions, estimates, and conclusions are based on the author's best judgment at the time of publication, and are subject to change without notice. The author undertakes no obligation to correct, update or revise the information in this document or to otherwise provide any additional materials. Past performance is no guarantee of future returns.

Recommended For You

Comments (54)

To ensure this doesn’t happen in the future, please enable Javascript and cookies in your browser.
Is this happening to you frequently? Please report it on our feedback forum.
If you have an ad-blocker enabled you may be blocked from proceeding. Please disable your ad-blocker and refresh.