Technology stocks got a huge boost over the past year in a pandemic-influenced economy. Organizations around the globe have accelerated their transition to more digital-based operations that enable flexibility and remote work and help save on costs.
Adobe Systems (ADBE -0.77%) and DocuSign (DOCU 0.10%) are two cloud-based software firms that tout the ability to help with this digital transformation and that suggests they have plenty of growth potential ahead. However, one of them is a better buy at this juncture.
Creative software for a new digital era
Adobe, with its suite of software for creativity and design, has been around since the early 1980s. It's remained in steady growth mode over the decades and has transitioned its services to a new era favoring subscription-based services delivered via the cloud. Along the way, Adobe has also added new areas of expertise aimed at things like digital marketing, electronic signatures, and collaborative document editing (where it competes head-to-head with DocuSign).
Image source: Getty Images.
This software giant's core proficiency remains rooted in creativity, though, and widespread lockups in industries like advertising, movie and TV show production, and other digital design work throttled its growth last year. Full-year fiscal 2020 revenue expanded "only" 15% to $12.9 billion as a result. However, as Adobe begins to lap the initial effects of the pandemic and many of its customers and prospective customers start to loosen their purse strings again in 2021, the company's revenue trajectory is beginning to reaccelerate. Fiscal 2021 first-quarter revenue notched a 26% year-over-year increase, and management expects full-year results to increase in the low 20% range.
As Adobe is already covering basic operational expenses, adding additional paying users to its ecosystem creates an even bigger jump in its bottom line. Free cash flow surged 39% in Q1 2021 to $1.71 billion, an impressive free cash flow profit margin of 44% during the quarter. Additionally, Adobe ended the period with $4.96 billion in cash and equivalents and only $4.12 billion in debt -- giving it plenty of headroom to spend in new areas to promote further growth.
Adobe stock trades for a premium 17 times trailing 12-month revenue and 41 times trailing 12-month free cash flow, but it's not an unreasonable price tag given its proven track record and the massive digital transformation movement it's helping facilitate (tech researcher IDC expects digital updates on business processes to grow by a double-digit percentage the next few years and could reach $6.8 trillion a year worldwide by 2023). Indeed, Adobe needs only to capture a small slice of this massive pie to keep itself in an upward trajectory.
The scrappy upstart born in the cloud
DocuSign is a more recent arrival to the software industry. Born in the wake of the dot-com bubble in the early 2000s, the company is hyper-focused on e-signature and collaborative document editing. It also operates its own network of data centers for its cloud-based services and uses blockchain technology to manage electronic signer identity. Back in 2019, it launched the "Agreement Cloud" -- a suite of services available via subscription designed to make business interactions quicker, cheaper, and more secure.
With its focus on this remote work-critical service, 2020 was a boon for DocuSign. Many businesses were forced to adopt e-signature capabilities for the first time, and they aren't likely to revert to the way things were before COVID-19. The company ended its 2021 fiscal year with about 892,000 paying customers (adding over 70,000 during the fourth quarter alone) with full-year revenue increasing 49% to $1.45 billion. Its run is far from over. Management is forecasting a 30% increase in sales during fiscal 2022 (the 12 months ending Jan. 31, 2022).
Much like Adobe, DocuSign's tech platform also has the ability to scale the bottom line at a faster rate than revenue. In fact, it's early on in reaching an efficient and highly profitable size. Free cash flow increased 389% last year as it went from negligible free cash flow of $44 million to $215 million (good for a free cash flow profit margin of 15% last year). Don't expect a repeat of this triple-digit percentage profit metric increase, but there's nonetheless plenty of room for DocuSign to expand here. It ended the year with $866 million in cash, equivalents, and investments and total debt of $717 million.
Even after its stock took a tumble along with other tech stocks in March, DocuSign trades for a premium 26 times trailing 12-month sales and 178 times trailing 12-month free cash flow. It's a steep price tag but one that will moderate if the company can continue its run higher in the decade ahead. There's a more than decent chance it will. Businesses need more flexible ways to execute contracts and edit and share documents -- part of what DocuSign calls the "anywhere economy" -- providing plenty of opportunities to push its Agreement Cloud services.
Which is the better buy?
DocuSign expects to grow revenue at a faster pace than Adobe in the next year (about 36% faster) but trades for more than 50% price-to-sales premium and more than four times as much price-to-free-cash-flow. Granted, it's earlier on its journey as a profitable enterprise, but Adobe's bottom-line expansion is nonetheless impressive too. It's hard to argue against either of these cloud software firms given the size of the digital transformation movement that lies ahead, but at this juncture, I say Adobe is the better buy -- almost exhibiting value stock characteristics at the moment given its expected rise in free cash flow generation. DocuSign -- with its sky-high price tag -- has a tall hurdle to clear this year after an epic run in 2020, so Adobe gets my nod for now.
