Adobe (ADBE) stock plummeted after the company posted the earnings beat for FQ3 2024 on September 12. The stock is currently down 14% for the year, and this article is going to discuss whether the recent dip has created a buying opportunity.
Adobe is known for its leading software products that help individuals and teams with graphic design, video editing, and web development, among many other use cases. It’s the product to go for if you’re a professional in the creativity and design businesses.
I am bullish on Adobe because of its wide moat, its lucrative business model, and the fact that it’s fairly valued at current levels. However, before getting into all of that, let’s take a look at the most recent quarter and what led to the sell-off.
What Caused the ADBE Stock Sell-Off?
In my opinion, Adobe’s most recent quarter was not bad at all, and I see the sell-off as an overreaction to guidance. Total revenue grew 11% year-over-year to $5.41 billion and beat Wall Street expectations by $34.9 million. EPS grew even more impressively by 23% year-over-year to $3.76, ahead of the market consensus by $0.26. Moreover, the company’s operating cash flow grew to $2 billion, an increase of 8% year-over-year.
While the quarter was solid, the guidance was not, and that’s what led to the sell-off. Management expects revenue growth to decelerate in FQ4 2024, projecting revenue between $5.5 billion and $5.55 billion in sales. Wall Street wanted a higher number, and when management slightly under-projected, the stock just got hammered. I believe the sell-off was an overreaction.
Now, let’s talk about everything there is to appreciate about Adobe’s business.
Adobe’s Wide Moat Enables Pricing Power
Adobe’s reputable brand and legacy, which constitute its moat, are central to my long-term bullish outlook on the stock. It’s the name that comes to mind whenever you think about design or creative work. According to data from 6Sense, Adobe holds an estimated market share of 58% in the app development market. That’s just one report. If you take a granular look at the market share of Adobe’s products and services, you’ll find that it dominates many of the categories it operates in.
As a result, this wide moat, defined by its brand and legacy, allows Adobe to enjoy pricing power. Its gross margins over the trailing twelve-month (TTM) period sit at an impressive 89%, and its operating margins are at 36%. Not only does it have products that resonate with customers, but it also has the ability to manage costs.
Therefore, Adobe’s industry-leading position, coupled with its competitive advantages, should allow it to continue to pass costs to customers and drive bottom-line profitability in the long term, as it has in the past. Over the past 10 years, its net income has compounded at approximately 36% on a TTM basis, more than double the rate at which sales grew (CAGR of approximately 17% over the comparable period).
Adobe Has an Extremely Profitable Business Model
In light of these competitive advantages, I appreciate Adobe’s extremely profitable business model. Since it’s a software company, it doesn’t need to reinvest a large chunk of sales back into the business to grow. For instance, Adobe’s TTM operating cash flow is currently $6.7 billion as its CapEx over the same period is just $182 million. It’s not a struggling business; it’s a healthy business. I believe asset-light businesses are good ideas for long-term investments since they can grow without giving up a huge chunk of sales every year.
Moreover, Adobe earns revenue from subscriptions, which again fits into the equation of a lucrative business model. Adobe charges customers a subscription fee, which they pay on a monthly or annual basis, to use the company’s products and services. In FQ3 2024, the company’s Remaining Performance Obligations (RPO) jumped 15% year-over-year to $18.14 billion. This metric is important because it represents unearned revenue that investors can look forward to.
Consequently, an asset-light subscription-based business model makes Adobe a solid pick for long-term growth investors. As the company continues to grow, I see more recurring revenue being generated and a lot of value being created for shareholders in the process.
Adobe Is Fairly Valued
Finally, I believe Adobe is fairly priced at current levels as it trades at 25 times this year’s earnings estimate, given the potential it has to still drive bottom-line growth. It’s not cheap, but it’s also not expensive.
Additionally, I believe Wall Street is a little too pessimistic about growth going forward since they expect earnings to grow by 12.4% next year. Given how Adobe’s growing, I believe it can beat analysts’ expectations, as it has done consistently over the past eight quarters.
Analysts’ Take on Adobe Stock
On the Street, Adobe stock sports a consensus Moderate Buy rating based on 23 Buys, 5 Holds, and 2 Sells. The average ADBE price target of $622.18 implies an upside of 20.72% from current levels.
The Bottom Line
Adobe is a high-quality blue-chip stock to own, not trade. Its wide moat, coupled with its asset-light business model, positions it ideally for continued compounding. I remain bullish on the stock and see it creating significant value for shareholders as the company continues to execute strongly. The recent dip in Adobe stock has indeed created a buying opportunity for long-term investors looking for growth at a reasonable price.
