Businesses of all sizes depend on Adobe's (ADBE -1.31%) products daily, with more than 90% of creative professionals relying upon the company's Photoshop product. Getting a bit more granular, Adobe securely captured more than 8 billion digital signatures last year through its Adobe Document Cloud program. In addition, the company is beefing up its offerings by acquiring Figma, a popular emerging collaborative design application. All of this is a large part of why Adobe is one of the world's leading software companies.
But Adobe stock has had a rough time in 2022, with it down 42% year to date. The broad-market sell-off, along with an adverse reaction to its Figma acquisition and the tech bubble in 2020 and 2021, contributed to the drop. Did the stock hit bottom at $275 per share earlier this year? Possibly, but short-term market fluctuations are unpredictable. The long-term opportunity is clear, however.
Here's a closer look at why investors shouldn't count Adobe out just yet despite its struggles.
Adobe's sales, income, and cash flow are climbing
While Adobe's stock dropped, its results rose. Buoyed by 2022 sales gains in segments like digital experience (up 14%) and document cloud (up 21%), Adobe generated $7.8 billion in cash from operations (CFO) in the year and $6.1 billion in operating income on record revenue. As shown below, each metric has risen for several years.
ADBE Cash from Operations (Annual) data by YCharts
Adobe expects to reach at least $19.1 billion in sales in fiscal 2023. This is hardly a declining business, as the stock drop suggests. Its flagship Adobe Photoshop, Illustrator, and Acrobat programs (the Creative Cloud) continue to grow sales. At the same time, Document Cloud, which allows for paperless document sharing, signing, and other functions, looks set to continue penetrating the market. If you have recently purchased a home or electronically signed a PDF document for a host of other purposes, you know how convenient and efficient this is.
Welcome Figma to the family
Companies that thrive by enhancing user experiences and creating efficiencies for businesses must stay on the cutting edge. Adobe spent more than $5.5 billion on research and development over the past two years. But sometimes it's more efficient to purchase a ready-made product than to develop it from scratch.
Figma's real-time editing collaborative software is a favorite of designers, engineers, and marketers. Employees at Microsoft (which is a large user of Adobe products) reportedly love it. Seeing this fledgling competitor take hold, Adobe swooped in with a $20 billion offer to purchase Figma.
That figure represents 50 times Figma's expected 2022 annual recurring revenue (ARR) of $400 million. There is no doubt that the price tag is expensive. However, Figma is experiencing ARR growth of 100%, has a 90% gross margin, and is cash-flow-positive already. It looks like Adobe overpaid now, but letting Figma grow into an immense competitor isn't a good strategy. Adobe paid a lot, but shareholders may be happy it did down the road.
Adobe's stock is historically inexpensive
It's important to value a company based on cash flow as well as earnings, as these are critical attributes of success. Just as the price-to-earnings (P/E) ratio measures the company's stock price compared to its earnings per share, the price-to-free cash flow (P/FCF) ratio measures the stock price against the free cash flow produced. Free cash flow is the amount of money left over after the company pays its operating expenses and capital expenditures (CAPEX) and is a terrific measurement of the health of the business.
Adobe's P/E and P/FCF ratios are significantly below historical averages, as shown below, which suggests that the stock is undervalued.
ADBE Price to Free Cash Flow data by YCharts
The undervaluation may mean that the market is pricing in a drastic decline in results; however, Adobe's fiscal 2023 guidance doesn't reflect this, even with management likely expecting a recession.
Like many tech stocks, Adobe stock was likely overpriced in 2020 and 2021. Now it looks like it has overcorrected. Long-term investors could significantly outperform the market in 2023 and beyond should the valuation revert to its historical averages.
