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Nearly every business relies on software for its day-to-day operations. That fact makes large-cap software companies like Adobe Systems (NASDAQ:ADBE) far more reliable than they used to be.
In this segment from Industry Focus: Tech, host Dylan Lewis and Fool.com contributor Brian Feroldi explain why this subscription software specialist is well-positioned to thrive during a market downturn.
A full transcript follows the video.
This video was recorded on Jan. 11, 2019.
Dylan Lewis: All right, Brian, climbing up the risk ladder, we've got our last stock. I think this is probably for folks that have a little bit of a longer time horizon. It's a steady business, but there's a lot of growth priced into it. That's Adobe Systems, maybe a name that a lot of people interact with, but haven't quite thought about investing in.
Brian Feroldi: Adobe is a company that I've known about for years and I never dug into it. But once I started to really understand this business, this is $110 billion company. It's huge. It's a top-tier software company. It's actually one of my favorite stocks in the entire market right now.
Most people are familiar with Adobe's what's called its Creative Cloud [software-as-a-service] offering. That's where it has products like Photoshop, Illustrator, Premiere Pro, Acrobat. A lot of those products are basically the gold standard in the creative community. Millions of designers and videographers and animators are trained and use those products. They can't do their job without them. It's an extremely dependable business.
Beyond the Creative Cloud products, Adobe has actually been moving into what's called a digital experience unit. That's where it provides cloud-based marketing and analytics tools to enterprise customers. It can help with creating marketing campaigns, analyzing them, increasing your presence in the e-commerce market. They actually have a sizable business that serves specifically business and enterprise customers.
Lewis: Something that's fascinating with this stock in particular is, we go back and look at the history, the stock did not fare particularly well during the 2007, 2008 recession. The stock fell about 65% from its 2007 high. But, you look at how the company performed this past year, when the S&P 500 sold off about 4%, they posted 29% gains.
Feroldi: Yeah. The comparison between now and 2008 is not apples to apples. A couple of years ago, Adobe switched its business model from doing a licensing model to forcing all of its users to go to a software-as-a-service model. Previously, during the last downturn, if somebody wanted to delay upgrading to the latest Premiere or the latest Photoshop, they could do so. Now, they're subscribing to Adobe services. That's a recurring bill that they're paying every month, regardless. I believe that if a downturn was to come, Adobe's financial statements would actually hold up much better than they did during the last downturn.
But even during the last downturn, the numbers weren't horrible. Their sales dropped 13%. That's not great, but considering the market environment they were in, that's not terrible, either. They were still profitable, although their net income did fall in half. But I believe that if a big recession was on the horizon, their business model now would allow them to hold up much better.
Lewis: For all of us characterizing them as a high-flying growth stock, their valuation doesn't look all that different than Microsoft's on a trailing basis. They're at about 45 times earnings, on a forward basis 25 times earnings. They aren't as built-out and established as Microsoft is. But to your point earlier, they are the de facto software for all of these enterprise clients that are doing anything in the creative space.
Feroldi: Yeah. A few years ago, when they made the switch to a purely cloud-based, as we spoke about on our software-as-a-service show, it did cost them revenue and profits in the near term. Their revenue and profits did hit when they switched their business model. However, if you fast-forward to today, their revenue is growing at a 20% rate, and their earnings are growing even faster than that. Over the last five years, this is a business that's put up earnings growth of 48% annually. That's just huge. That rate is projected to fall to 22% over the next five years, but if you compare that to their valuation of about 25 times next year's earnings estimates, that's a very fast growth rate for basically a slight premium to the market. I think Adobe's stock will probably hold up pretty well if it can deliver on its growth targets.
Lewis: Brian, I didn't realize this as we were planning out the show, but now that we've talked about all three companies, I see another thing that was not included in our criteria, and that's steady payments, routine purchases. All of these businesses, whether it's Verizon with subscribers paying a monthly payment to them to use their network, or Microsoft with its software products, or Adobe with their software products, all of these have recurring revenue streams in one way or another. They are not banking on one big product release to make numbers.
Feroldi: Yeah, that's correct. When you can count on recurring revenue vs. a one-time sale, it's the gift that keeps on giving. Your financial statements become much more dependable, and Wall Street generally rewards that with a more stable stock price.
Lewis: Brian, you did a write-up recently on Adobe. If anyone wants that in written form rather than in audio, that's available.
Feroldi: Yes, absolutely. It's right on fool.com.
Lewis: Listeners, if you want that, shoot us an email over at email@example.com. We'll make sure to send that your way.