Adobe's deep discount

As with so many tech stocks over the past year, Adobe’s share price has been in the firing line, falling 60% from the November 2021 peak. Even after a rally from the lows, Adobe shares are trading below the Pre-Covid highs and the company is set to report earnings on Thursday. Adobe’s our pick for stock of the week.

Starting with the chart and the 2021 monetary and fiscal excesses that pushed valuations into the stratosphere…

Those excesses have clearly been unwound as Adobe's shares now trade below the Pre-Covid peak. The pandemic nosebleed levels are a distant memory. Does that mean it's an excellent value buy now? The discount from both peaks is certainly enough to prompt the question… And it did for Goldman Sachs analysts back at the start of October.

Their research note, titled Best-in-Class Cash Returns at Reasonable Cash Flow Valuations lasered in on stocks that had been particularly resilient during periods of sharp market drawdowns, with a view to highlighting the defensiveness of stocks with superior financial returns.

How do the analysts define superior?

“a solid track record of generating superior financial returns (measured using cash returns on cash invested or CROCI) that our analysts expect will continue into 2023E alongside valuation support (in the form of attractive debt-adjusted cash flow yields) — characteristics that should make them favourably positioned across market environments.”

In layman’s terms, it’s all about the cash flows. Is the capital investment resulting in higher revenues? In Adobe’s case, the answer has generally been yes. Although, the company’s decision to buy Figma for $20 billion did raise doubts (and a few eyebrows).

CFO Dan Durn defended the acquisition:

“One, we extend Figma’s reach to our customers and through our global go-to-market footprint. Two, Figma accelerates the delivery of new Adobe offerings on the web to the next generation of users. And three, we jointly introduce new offerings to the market as we unlock the possibilities of collaborative creativity.”

The deal was already in the public domain when Goldman’s analysts passed judgement via their CROCI model:

Adobe is a market leading franchise with a dominant position in a growing TAM (Total Addressable Market). Adobe is on a path to grow revenues by 2x to 3x from current levels over the next few years, driven by both new subscriber growth and pricing leverage. This would place the company amid the top ranks of software companies with $40bn+ of revenues. Double-digit top line growth should also drive several years of durable, low-to-mid-teens earnings growth.

The analysts believe that stocks with these characteristics, such as Adobe, will prove resilient against a backdrop of slowing growth, persistent inflation and rising real rates.

This weeks’ earnings report may confirm or add doubt to their view. Expectations (via Newsquawk) are as follows:

• $3.50 Quarterly Earnings Per Share
• $4.53bn Quarterly Revenue
• $13.63 Full Year Earnings Per Share
• $17.61bn Full Year Revenue

The accompanying commentary will, as always, be worth paying attention to. If Adobe can navigate these testing times and continue to grow revenues, then buyers could be tempted.