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Is Adobe Systems Stock a Buy?

By Brian Withers - May 16, 2020 at 10:45AM

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The best days might still be ahead for this software innovator.

Adobe Systems Inc.'s (ADBE 1.34%) stock has climbed an incredible 358% over the last five years and has delivered a 10-bagger for investors who've held the stock for the last decade.

These gains have been driven by its dominance in software for creatives and document management, but over the past few years, it's expanded into an even bigger market. Let's take a look at where the company is today, its growth levers, how it might be impacted by the coronavirus pandemic, and decide if this stock is worth adding to your portfolio.

ADBE Chart

Stock price graph for the last five years through March 14, 2020. ADBE data by YCharts

The business of a software powerhouse

Adobe reports its revenue in three segments: Digital Media (made up of its Creative Cloud and Document Cloud products), Digital Experience, and Publishing (a small set of legacy products). Because its Creative Cloud is its largest moneymaking product set, it's separated in the table below.

Segments

2019 annual revenue

% YOY growth

2022 addressable market

2019 Revenue as a percent of 2022 addressable market

Digital Media (Creative Cloud)

$6.5 billion

21%

$31 billion

21%

Digital Media (Document Cloud)

$1.2 billion

25%

$13 billion

9%

Digital Experience 

$3.2 billion

31%

$84 billion

4%

Publishing

$0.3 billion

(1%)

Not reported

N/A

Total revenue

$11.2 billion

24%

$128 billion

9%

Data from Adobe's 2019 10-K and its November 2019 Financial Analyst Meeting slides. Table and calculations by the author. 

Creative Cloud is a broad set of tools for creative professionals that create content for advertising, video games, video, and more. Some of its most well-known products include Photoshop, Illustrator, and Lightroom. Its Document Cloud business is centered around its Adobe Acrobat software that creates and manages what's become the standard for document files, the Portable Document Format (PDF). 

Its Digital Experience segment provides tools for customer-journey management, data insights, commerce, content, and advertising for its business customers. This also is its largest growth opportunity.

A circuit board with a highlighted chip with a cloud on it.

Adobe's cloud software is helping the digital transformation of enterprises. Image source: Getty images.

Multiple opportunities fueling growth 

In our digitally connected world, consumers have more choices than ever before, and switching costs are often low. Brands need to stand out and create memorable experiences online to attract and retain customers. The Digital Experience product suite has been helping businesses undergo this kind of digital transformation for the last decade. Adobe is investing heavily in this segment with two massive acquisitions in 2018: Marketo, a marketing cloud platform purchased for $4.7 billion; and Magento, an e-commerce platform, at a price of $1.6 billion. Adobe also bought TubeMogul in 2017, a video-advertising platform for $561 million. Between acquisitions and 10 years of building out this product suite, this segment has significant momentum which will enable it to grow in this massive $84 billion market.

For its Digital Media products, Adobe is solidifying its industry-leading position by engaging with its community of users to shape the product roadmap. Armed with these customer insights, Adobe's development teams have delivered an amazing 24 new products over the last two calendar years, helping to drive this segment's 22% revenue growth last year.

A presentation slide listing the products released each year between 2016 and 2019. Each year the number increases: 6 in 2016, 9 in 2017, 11 in 2018, and 13 in 2019.

Adobe has an impressive new product development track record. Image source: Adobe's November 2019 Financial Analyst meeting slides.

Lastly, it's working to make its creative products more accessible to non-career creatives, which it calls "consumers and communicators." Mobile-only apps, template-driven content design, and lower-priced subscriptions like the $9.99 photography plan are efforts to appeal to this customer set, which make up more than half the addressable market for its creative cloud products.

The company has plenty of optionality for long-term growth, but investors may be worried about how it will fare in the year ahead.

Coronavirus uncertainties ahead

In the most recent earnings call in mid-March, CEO Shantanu Narayen shared some insights into how the company will fare in response to COVID-19: "We expect some enterprises will delay bookings, postponed services implementation and reduce expenses." He went on to say its business is set up for the long term with three massive market opportunities. The business leaders Narayen has talked with are prioritizing the safety and well being of customers and employees, but they noted that digital transformation efforts have an even stronger case than before. 

The company's financials are solid and allow a measured response to a downturn if needed. With 89% of revenue coming from subscriptions, it lets the company easily monitor what is happening to the top line, so it can manage costs appropriately. It ended the most recent quarter with $4.2 billion in cash and short-term investments with a tremendous $1.3 billion in cash generated from operations. CFO John Murphy ended his remarks in the last earnings call saying that its tremendous opportunity combined with its financial model "should enable us to deliver solid results as the world navigates the COVID-19 situation."

The bottom line for investors

Adobe has a lot going for it, and the market has rewarded it with a premium valuation. It sports a lofty price-to-sales ratio of 15 and an equally pricey trailing price-to-earnings ratio of 54. But this 37-year-old software specialist is a proven operator that has created three multi-billion dollar subscription businesses. In my book, that's the kind of results that are worth paying a premium for. If you are a long-term-minded growth investor, this stock is a buy today. It probably won't return a 10-fold gain over the next decade from here, but investors can rest easy knowing it should create market-beating returns for the foreseeable future.

Brian Withers has no position in any of the stocks mentioned. The Motley Fool recommends Adobe Systems. The Motley Fool has a disclosure policy.

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