Few software companies have achieved the level of success of Adobe (ADBE -0.84%). With world-class margins and an industry-standard product line, Adobe is a role model for many software companies.
Its business success has directly translated into its stock's performance, up 750% over the past decade. However, the stock has fallen on hard times recently, down more than 40% since peaking in late 2021. At these levels, the stock looks undervalued, but is this writing on the wall? Or is there a genuine bargain here?
The Figma acquisition raised some eyebrows
Adobe's software suite is primarily marketed to anyone in the graphic design field, although it also has general business software used to modify and create PDFs. Part of the reason Adobe has become the industry standard is that its software is used and taught in high school and higher education. By capturing this audience, Adobe has a strong foothold in the graphic design space.
However, some might argue that Adobe has gotten a little too comfortable in its dominance.
In one area, the creative cloud, where designers can collaborate to create designs, Figma was eating Adobe's lunch. So, Adobe decided to buy Figma ... for $20 billion in cash and stock. This caused many investors to question Adobe's leadership, which is typically responsible with finances. As a result, the stock dropped 17% the next day and has just recently regained those losses.
The biggest caveat of the purchase was the price: 40 times sales. Although this was normal during elevated levels in 2021, it's far from the norm in 2022 and 2023. Regardless, the U.S. Department of Justice is expected to express objections to the acquisition on antitrust grounds, so it may not be able to proceed.
Even if the Figma acquisition doesn't go through, this experience may have triggered a reminder within Adobe that it can't stay stagnant in its product line. This could spur future innovation and allow Adobe to continue its growth path.
But right now, Adobe is trading like its best days are behind it.
Adobe has best-in-class free-cash-flow generation
Adobe produces loads of free cash flow (FCF) -- over the past 12 months, it converted 41% of revenue into FCF. This gives Adobe lots of financial flexibility to make moves like repurchasing shares or making acquisitions (such as Figma). In fact, Adobe could produce enough FCF in three years to cover the entire $20 billion Figma acquisition.
By dividing its FCF by its market cap, you can value a company utilizing this metric, too.
ADBE Price to Free Cash Flow data by YCharts
With Adobe trading around its lowest levels since 2014 (when it switched from a license to a subscription model), the stock looks like a bargain.
Its business isn't doing too badly, either. In the first quarter of fiscal 2023 (which ended March 3), revenue rose 9% year over year. While this isn't a blazing-fast growth rate, Adobe is still executing during a period of economic uncertainty, something that is invaluable to investors.
Analysts expect 10% revenue growth for the rest of this year, and 12% next year. Investors must understand that Adobe likely won't become their portfolio's next multibagger.
However, it's a consistent company currently trading at a bargain valuation. Adobe makes an outstanding stock to balance out some riskier companies in a portfolio. With the stock well off its all-time highs, now looks like an excellent opportunity to pick up some shares.
