Quality comes with an expensive price by TipRanks

© Reuters. Adobe Stock: quality comes with a high price

Adobe (NASDAQ 🙂 is making its mark on the future of digital media and digital marketing, with the company essentially monopolizing its industry.

Adobe has graciously leveraged the benefits of its recurring SaaS revenue model, providing its software and tools through a monthly subscription. Its suite incorporates the most advanced and comprehensive tools in its field, including software like Photoshop, Illustrator, and After Effects, which are widely considered to be essentials for effectively any type of digital creator. (See ADBE stock charts on TipRanks)

Plus, since the creators are automatically subscribed to the entire suite, they usually don’t bother and / or need to look for substitutes. As a result, Adobe enjoys a fantastic gap in its industry, leaving virtually no room for competition.

However, despite Adobe’s moat and overall qualities, the stock’s expensive valuation is likely to limit its further rise. I’m bullish on the stock, but Adobe certainly isn’t cheap.

Unstoppable growth momentum

Adobe released its second quarter results in June, recording another quarter of exceptional growth in both revenue and bottom line.

Revenue was $ 3.84 billion, indicating 22.7% year-over-year growth, fueled by a growing global customer base that continues to show phenomenal momentum.

In particular, Adobe’s Digital Media division (which involves the company’s flagship software and is its largest contributor to revenue) recorded 25% year-over-year revenue growth to $ 2.8 billion. In fact, it added in new annualized recurring revenue (ARR) of $ 518 million, bringing the ARR to a new record high of $ 11.21 billion.

Supported by strong performance in its Digital Experience and Publishing / Advertising segments, second quarter results propelled Adobe’s LTM revenue (last twelve months) to a new all-time high of $ 14.4 billion . To underline the strength of Adobe’s momentum, its LTM revenues have now reached new highs for 29 consecutive quarters.

Valuation, return on capital

Following Adobe’s latest results, the stock has continually hit new all-time highs, reaching $ 673.88 on September 3.

Management provided its outlook for the third quarter, forecasting revenue growth of about 22% to $ 3.88 billion and GAAP EPS of about $ 2.27. Combined with the results released in the first half of the year, analysts estimate EPS for fiscal 2021 to be around $ 12.25.

On the one hand, Adobe’s results are once again impressive. On the flip side, stocks have rallied disproportionately to Adobe’s financial growth, leading to a worrying expansion in valuations.

The stock is currently trading with a futures P / E of 51.2, which is considerably higher than its all-time average of around 33. Considering that income growth is expected to remain robust, but not supernaturally accelerating, one could assert that the stock is overvalued.

Additionally, Adobe’s ability to return cash to shareholders has also been somewhat limited at its current valuation multiple. Since Adobe uses share buybacks as its only method of return on capital, the company is essentially “overpaying” to buy back its own shares.

The Taking of Wall Street

When it comes to Wall Street, Adobe has a strong buy consensus rating, based on 18 buys, two suspensions, and no sells awarded in the past three months. At $ 661, ADBE’s average price target implies a 2.6% hike.

Final result

Overall, Adobe is without a doubt a fantastic company, with a wide divide and great prospects for growth as the digital economy continues to grow.

However, the stock certainly comes at a premium price. I’m bullish on the stock for its long-term potential, although Adobe is by no means attractively priced.

Disclosure: At the time of publication, Nikolaos Sismanis does not have a position in any of the titles mentioned in this article.

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