Adobe (ADBE -1.57%) is one of the top tech companies in the world. But in recent months, it has been struggling. In a testament to its general stability, Adobe's stock fell 10% after the company reported earnings in December (its guidance didn't impress analysts), if not for the early stages of the pandemic in 2020 when the market as a whole was crashing, it would have been the stock's worst performance in the past decade.
However, investors shouldn't focus on the short term. If you're willing to buy and hold, then this is a stock that has the potential to produce some strong gains for your portfolio. The following three numbers demonstrate why you shouldn't give up on Adobe as a long-term investment.
Image source: Getty Images.
27.5% annual growth rate in SaaS
Adobe is a great software-as-a-service (SaaS) stock. It offers its top software products available to users on a recurring subscription, including Photoshop, Illustrator, and Acrobat, which are all within its Creative Cloud package. For the three-month period ending March 4, Creative Cloud generated $2.5 billion in sales for the company and accounted for 60% of all revenue.
Although investors may be concerned about lackluster growth in that area of its business (Creative Cloud's revenue only rose at a rate of 7% year over year), there are still many more opportunities ahead for the business. According to estimates from Fortune Business Insights, the global SaaS market will be worth $716.5 billion by 2028 -- more than five times its value in 2021 ($130.7 billion). That implies a compounded annual growth rate of 27.5% during the period. And growth in cloud applications is also continuing to rise:
As companies are changing how they work, including more employees working remotely, there is a greater movement toward more digitalization and flexibility to have access to products in the cloud. And with Adobe's products being the cream of the crop in the photo editing world, it will likely be a huge benefactor of the growth in SaaS.
93% subscription revenue
Given its subscription-based products, it should be no surprise to investors that Adobe reports the bulk of its sales from recurring revenue. But what's impressive is that the percentage has been increasing over time. In its most recent quarter, subscription revenue represented a whopping 92.9% of its top line. That's up from 91.8% a year ago and higher than the 89.5% it accounted for in the last fiscal year before the pandemic (period ending Nov. 29, 2019).
Being largely a subscription-based business helps Adobe generate strong gross margins since its operations are lean:
ADBE Gross Profit Margin (Quarterly) data by YCharts
In the past five fiscal years, the lowest that Adobe's profit margin has been was 23% (and as high as 41%). A strong gross margin helps make that possible and ensures that, as the company's sales continue to grow, more of that incremental revenue will flow through to the bottom line.
$22.7 billion in free cash
A key number that growth investors should always consider is free cash flow. A business that burns cash may need frequent stock offerings (which means dilution for existing shareholders). That isn't a problem for Adobe, and over the past five years, it has generated $22.7 billion in free cash flow.
Significant free cash can open up more opportunities for Adobe to either take on acquisitions or reinvest in its business. And that means investors don't need to be discouraged that the growth rate isn't incredibly high right now; over the long haul, that can change.
Is Adobe a buy today?
So far this year, shares of Adobe are down more than 21% (the S&P 500 has fallen 6%), recently hitting a new 52-week low of roughly $408. Although the stock isn't cheap, trading at a price-to-earnings multiple of 44, the company's solid financials, margins, and opportunities in the SaaS market make it tenable for investors to accept a premium -- the average earnings multiple in the Technology Select Sector SPDR Fund is only 28.
Adobe isn't a stock that you'll likely find trading at a discount, and its dip in value this year may pose a great opportunity to buy it right now, especially if you're willing to hang on for the long term.
