The trillion-dollar market cap club is an exclusive group. Only six U.S. companies have achieved this valuation, although many are close. Adobe (ADBE -1.27%) has about a $300 billion market cap, meaning its stock must rise more than 25% annually to achieve this status by 2026. Can Adobe do this in five years to join the ranks of behemoths like Apple, Microsoft, and Tesla?
Two leading segments and one legacy segment
Adobe is more than the company that opens PDF documents. It operates three segments: digital media, publishing and advertising, and digital experience. Its largest segment, digital media, pulled in nearly $3 billion in revenue during the third quarter. Its suite of software includes products like Photoshop, Acrobat, and Premiere Pro and has more than 20 apps overall. Linking them all together is the Creative Cloud, allowing users to collaborate from anywhere at any time.
Image source: Getty Images.
Digital experience gives businesses tools to analyze marketing spend, manage ad campaigns, and optimize advertisements. This segment is the fastest-growing; it reported 26% year-over-year growth last quarter and contributes 24% of Adobe's total revenue.
Finally, publishing and advertising is the legacy portion of Adobe's business. It includes software licenses and printing technology. This business' revenue has been declining, but only makes up 3% of Adobe's total revenue.
World-class margin profile
Adobe's revenue is mostly subscription, which creates a continuous purchasing cycle for customers. Subscription revenue grew 24% in the third quarter and had an impressive gross margin of 91%. In the fourth quarter, management is projecting $550 million of new annually recurring revenue (ARR), pushing its total quarterly revenue above $4 billion for the first time.
To achieve the lofty trillion-dollar goal, Adobe must maintain its current growth rate. But it has another card up its sleeve to further help.
As of Sept. 3, Adobe has a share repurchase authorization of up to $13.1 billion expiring in 2024. That constitutes about 4% of the company at today's market cap. Once the authorization is completed, investors shouldn't be surprised if Adobe seeks approval for more repurchases.
Over the last 12 months, Adobe has produced $6.6 billion in free cash flow. This translates to a remarkable 44% free cash flow margin. Few companies are even close to this amount of free cash flow generation. Producing piles of cash allows Adobe to acquire businesses or repurchase more stock. Either will drive it closer toward the trillion-dollar valuation.
A strong competitor in digital signatures
Adobe will need to develop new revenue streams to maintain the growth rate it has been accustomed to. One area is the Adobe Document Cloud, which grew 31% in the third quarter. This segment is under the digital media umbrella and is competing against DocuSign (DOCU -2.03%). COVID-19 provided a boost to the digital signature industry and cloud document management.
Subscription revenue for Adobe's Document Cloud and DocuSign was exactly the same at $493 million in the quarter ending in July. But DocuSign is growing quicker at 52% versus Adobe's 31%. This space has room for two winners, but Adobe will need to dominate if it hopes to join the trillion-dollar market cap club.
Reaching that market cap by 2026 will not be easy. However, with its strong cash flow, stock repurchase program, and solid growing businesses, it has a real chance. Even if it doesn't hit that lofty goal, Adobe is an incredible company and a solid investment.
Although its stock is near all-time highs, it deserves trading there because of its strong execution. Investors looking for a solid growth company that won't have crazy price swings would be wise to add Adobe to their portfolio.
