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Why Patient Investors Should Watch the Dip in Adobe

By Al Lewis – Oct 6, 2021 at 7:34AM

Key Points

  • Adobe recently reported record revenues and offered a strong forecast for the rest of the year.
  • The company has demonstrated over several decades that it can thrive in a constantly disrupted industry.
  • A recent pullback in its stock price may prove an opportunity for patient investors.

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A solid company with strong results has a sagging stock price, for now.

Sometimes a long-established company has its engine firing on all cylinders -- but its stock just sputters. Adobe (ADBE -0.45%) released yet another solid earnings report on Sept. 21, but investors apparently wanted more. The stock has since fallen by more than 10%, possibly creating an entry point for more patient investors looking more into the future.

Adobe reported record revenue of nearly $4 billion in its third quarter, marking 22% annual growth. Net income was up nearly 27% to more than $1.2 billion over the same quarter last year. The company also forecast continued strong results for the fourth quarter, and it's buying up its own stock. It repurchased 1.7 million shares in the third quarter as part of a plan to buy back up to $15 billion in stock through 2024 -- a plan that shows management's commitment to supporting the company's stock price. 

Adobe CEO Shantanu Narayen kicks off a big conference in Las Vegas in 2019.

Adobe CEO Shantanu Narayen kicks off a big conference in Las Vegas in 2019. The pandemic has forced Adobe to offer virtual meetings. Image source: Adobe.

Solid in the cloud

Investors focused on the stock's recent pullback shouldn't lose sight of where Adobe has been. The San Jose, Calif., software maker, founded in 1982, has created the tools used throughout the digital media space today, from Photoshop, Illustrator, and the simple portable document format, or PDF, to cloud-based video collaboration platforms.

The company boasts that 90% of the world's creative professionals use Photoshop, and that people opened more than 300 billion PDF documents last year. 

The company divides itself into three primary segments:

  • Creative Cloud, offering products for photography, video, animation and design.
  • Document Cloud, providing solutions for creating, editing, sharing, scanning, and signing secure digital documents.
  • Experience Cloud, which entails content management, personalization, data analytics, and e-commerce.

Note the key word there: "cloud." Adobe has moved its industry-standard products to the cloud, which ensures recurring revenue through subscriptions, eliminates software piracy and its lost revenue, and solidifies Adobe's place in an ever-more digital future. 

The company's products are deeply entrenched within a growing field of digital marketers, designers and content creators. It has a wide economic moat around its businesses, keeping competitors at bay, because it's always a big, unwelcome challenge for users to switch and learn new products.

And Adobe's products are highly profitable. The company boasts a net margin of more than 38% and a return on equity of nearly 45%.

Down, but not out

Adobe stock is down more than 14% from the all-time high it reached on Sept. 3. But it's still up more than 12% year to date.

It carries a 12-month trailing price-to-earnings ratio of 46, which is reasonable compared to other successful software giants. Salesforce (CRM -1.45%), for instance, has a PE of more than 105, and Intuit (INTU 0.48%) has a PE of nearly 70.

The bearish case for Adobe is simply that its stock was priced for knockout performance, and now it has pulled back -- even amid that knockout performance. The company also generally faces softer market conditions in the seasonally dicier months of September and October.

Also, the stock was arguably expensive at its high, and many investors likely followed the tried-and-true strategy of selling on the good news. For many investors, the stock may still look pricey. But it's important to remember that Adobe stock has long commanded a high valuation. After all, it's in the high-margin business of providing software. Some bearish critics also note that the once-rapid growth of Adobe's software-as-a-service offerings is beginning to slow down. 

Adobe further acknowledges that its business continues to be hampered by the pandemic. For instance, its conference and events have all been virtual, where they were in-person before COVID-19.

Worthy of consideration

Overall, however, Adobe offers a solid business with a long history of success in an industry pocked with failures. It has shown over several decades that it can adapt and even thrive in a constantly disrupted industry. Adobe has been growing for a long time, and it will likely keep growing for years to come, with a total addressable market that the company estimates will expand to $147 billion by 2023.

What's more, Adobe's biggest business remains creative software, and almost all of the revenue from that segment comes from subscriptions. That stabilizes revenue and makes the company's forecasts predictable. Analysts expect Adobe's revenues to grow at 18% a year over the next five years. 

Adobe has proven to be a smart play for the patient investor, and its recent pullback may represent a good time to buy.

Fool contributor Al Lewis holds no financial position in any companies mentioned. The Motley Fool owns shares of and recommends Intuit and Salesforce.com. The Motley Fool recommends Adobe Inc. The Motley Fool has a disclosure policy.

Stocks Mentioned

Adobe Stock Quote
Adobe
ADBE
$329.67 (-0.45%) $-1.48
Salesforce Stock Quote
Salesforce
CRM
$131.34 (-1.45%) $-1.93
Intuit Stock Quote
Intuit
INTU
$391.67 (0.48%) $1.89

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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