To The Moon

$Adobe(ADBE)$

The markets have opened with highly mixed results across various sectors. However, one standout movement is Adobe, which is down nearly 12%, aligning with the broader decline in the technology software industry. Looking at the past month, the market has been dominated by red, with many companies experiencing double-digit losses—Adobe included, which has dropped an additional 5%.

Improved Market Sentiment On a more positive note, market sentiment is slightly improving. Just a few days ago, fear levels were extreme at 13, but they have now risen to 22. The hope is that this trend continues, moving away from extreme fear into a more stable range.

Adobe's Earnings Report: A Closer Look Today, Adobe is in the spotlight following its latest earnings report. The company’s stock has hit a new 52-week low, having fallen 33% over the past year. This raises the question: is Adobe now an attractive buying opportunity, or should investors steer clear?

Wall Street’s View on Adobe Interestingly, both SEI Alpha and Wall Street analysts rate Adobe as a "buy." Additionally, the company’s forward price-to-earnings (P/E) ratio has been declining as its stock price has fallen. Over the past decade, Adobe has significantly outperformed the S&P 500, delivering a 400% gain to long-term shareholders. While the company currently does not pay a dividend, it had previously been a dividend payer.

Institutional Support for Adobe Institutional investors remain bullish, holding around 82% ownership. Despite Adobe’s stock decline, institutions have continued buying, with the most recent Q4 data showing net institutional purchases.

Overview of Adobe's Business For those unfamiliar with the company, Adobe is a multinational software leader known for its creative and digital media products, such as Photoshop, Premiere Pro, and Illustrator. It also provides document management solutions like Adobe Acrobat and PDF technology, along with cloud-based services through Adobe Creative Cloud and marketing tools via Adobe Experience Cloud.

Strong Earnings, But Concerns Persist The latest earnings report highlights key metrics:

• Revenue increased by 10% year-over-year.

• Digital Media and Digital Experience segments grew at double-digit rates, both boasting strong margins.

• Digital Media, which is Adobe’s largest revenue driver, has a 95% gross margin.

• Annual Recurring Revenue (ARR) for Digital Media surged by 133% year-over-year.

Analyst Worries Over AI Strategy Despite strong earnings performance, investor concerns remain. Adobe’s AI strategy is under scrutiny, with analysts questioning its ability to effectively monetize AI offerings. Additionally, Adobe’s revenue forecast disappointed some investors, as it merely met expectations rather than exceeding them.

Monetizing AI and Increasing Competition Wall Street analysts have long been wary of Adobe’s AI monetization potential, particularly as competition intensifies from AI-focused startups. The company’s Q2 revenue projection falls between $5.7 billion and $5.82 billion, aligning with analyst forecasts but failing to impress investors who seek companies that outperform expectations. Similarly, Adobe reaffirmed its full-year revenue target of $23.5 billion, which does little to alleviate concerns about AI scalability.

Solid Performance Despite Concerns That said, Adobe continues to grow its top line at a steady pace, with Q1 revenue reaching $5.71 billion—beating the expected $5.66 billion. Earnings per share (EPS) also exceeded estimates at $5.08 versus the expected $4.97.

Revenue Breakdown: Dominance of Creative Segment

A closer look at Adobe’s revenue breakdown reveals that its Creative segment remains the dominant force, accounting for more than 90% of total revenue. While the Document and Experience segments have been growing, they remain secondary in terms of overall contribution.

Subscription-Based Business Model

Adobe operates on a primarily subscription-based model, and this has steadily expanded over the years. However, revenue growth has slowed, dipping to 11% in 2024—a stark contrast to the higher growth rates seen in previous years.

Track Record of Beating Expectations

One positive note is that Adobe has a solid track record of beating earnings expectations, achieving this in each of the past four quarters. Analysts project continued EPS growth in the high single digits for the next year. Looking ahead to November 2025, Adobe’s projected EPS of $20.41 gives it a forward P/E ratio of 21.5—essentially in line with the sector median.

The Big Question: Can Adobe Sustain Growth? The key question remains: can Adobe maintain its growth trajectory and successfully monetize its AI initiatives?

Valuation Comparison and Stock Price Decline

One important point to consider is that, compared to its valuation over the last five years, where it was valued at 34.52, Adobe now trades approximately 38% lower. Despite this decline, the company has consistently increased its free cash flow over the past decade, currently standing at $20.80 on a trailing 12-month basis, nearly a tenfold increase since 2015. This trend is expected to continue over the next 12 months.

Growth Metrics and Future Expectations

In terms of growth, Adobe's revenue is up 11% year-over-year, with a forward-looking growth rate expected in the 10-11% range, which is higher than the sector's mid-single-digit growth. Over the past five years, Adobe has grown its top-line revenue at a slightly faster pace, around 14-15%. However, one area where the company falls slightly short in its ratings is the projected growth in earnings per share (EPS), which is expected to increase by 14%. This is on par with the sector but lower than its own five-year average of 16.1%.

Return on Invested Capital (ROIC) A strong point for Adobe is its Return on Invested Capital (ROIC), which has been consistently improving. A minimum of 10% is typically desired to demonstrate effective capital allocation, and Adobe has exceeded this threshold over the years, now sitting at an impressive 41%. This highlights the company’s ability to allocate its capital effectively.

Profitability and Cash Flow When looking at profitability, Adobe continues to impress. It has a 89% gross margin, well above the sector's 50% and its own five-year average of 88%. The bottom line sits at 26%, above the sector's 4%, although below its own five-year average of 30%. Adobe's cash from operations stands at $8 billion, well above its own five-year average of $6.8 billion and significantly higher than the sector's $103 million. This consistent cash generation has been a key strength for Adobe.

Operating Margin Efficiency Regarding operating margins, Adobe has shown significant efficiency improvements. In 2015, its operating margin was 19%, and it has since risen to 37%. This shows Adobe's ability to consistently generate free cash flow, maintaining a margin of over 5% annually, with small increases each year. For the trailing 12 months, it reached 42%, which is impressive for a technology company.

Share Buybacks and Debt Management

Adobe also demonstrates strong shareholder value returns, albeit not through dividends, as they stopped paying them. Instead, Adobe has focused on share buybacks, repurchasing around 10% of shares from 2015, reducing from 57 million to approximately 44.5 million shares outstanding. Additionally, Adobe's net debt to EBITDA ratio is noteworthy. It highlights the number of years it would take for Adobe to pay off all its debt net of cash, and it's projected that this will not take more than a year. This indicates a very strong balance sheet.

Valuation Model and Industry Position

As stock prices decline, so do forward valuations. Many companies in the S&P 500 still appear relatively overvalued, but Adobe, with its current valuation of 17, is one of the lowest in the technology software industry. Given its impressive metrics, Adobe's stock could be seen as an attractive investment at these levels.

Valuation and Intrinsic Value of Adobe Moving into Adobe's valuation, our intrinsic value for the company is $575, derived from our discounted cash flow (DCF) model. We’ve factored in Adobe's latest free cash flow for 2024, which grew by 23% year-over-year over the past 10 years. Looking ahead, we’ve used estimated growth rates of 10%, with low, medium, and high estimates of 8%, 10%, and 12%, respectively. As always, these numbers are subjective, and you can access a copy of the model by clicking the pinned comment below to run your own numbers for Adobe or any other stock.

DCF Calculation and Upside Potential Based on the 10% growth rate and the discount rate, we calculated the present value of future free cash flows, added the terminal value, and adjusted for cash and total debt to get the enterprise value (EV). Dividing by the number of shares outstanding gives us a fair value of $575 per share, which suggests a 49% upside. For those who believe an 8% growth rate is more accurate, the intrinsic value drops to $499, still offering a 29% upside. For those who consider 12% growth to be more appropriate, the intrinsic value increases to $662, representing a 71% upside.

Margin of Safety and Buy Price For full transparency, we also show the margin of safety (MOS) based on both the 8% and 10% growth assumptions. If you believe the 10% growth rate is more accurate, the buy price is $517, providing a 10% margin of safety. We maintain this MOS as our baseline, following our three golden criteria: a wide moat, strong financial metrics, and solid forward-looking data. The current stock price is hovering between 30% to 35% below the fair value, and Wall Street remains bullish, with a price target of $565 over the next year, indicating 46% upside.

Wall Street Price Targets and Future Potential For those who believe 8% growth is more realistic, the margin of safety becomes more significant. At the 10% growth rate, a buy price of $449 is suggested, and at a 20% margin of safety, the price drops to $398. This suggests that Adobe is not yet at the 25% margin of safety level but is still within the 20% to 25% range for those with a more conservative view. Wall Street's price target of $565 remains unchanged.

Conclusion

We would love to hear your thoughts: Do you think Adobe is a good buy at its new 52-week low with a 30% to 35% margin of safety, or do you believe it’s better to avoid, hold, or wait for a further dip?

Disclaimer: I want to make it clear that I am not a financial advisor, and nothing I say is intended to be a recommendation to buy or sell any financial instrument. Additionally, it's important to remember that there are no guarantees or certainties in trading or investing, and you should never invest money that you can't afford to lose.

@Daily_Discussion @TigerPM @TigerObserver @Tiger_comments @TigerClub