According to the analysts at Morningstar (MORN, Financial), earnings per share without non-recurring items for Adobe Inc. (ADBE, Financial) could jump from $10.10 per share for 2022 to $19.90 per share in 2025.
That implies average earnings growth of 24% per year (without compounding) and suggests the share price could rise significantly. Perhaps there would be even enough pressure to push the price back over the $600 mark again.
If so, that could also produce a doubling of the share price, from its current level of $322.32 to the $688.32 it hit on Nov. 19, 2021. That, of course, was when the price began to tumble, and kept on falling throughout most of 2022.
The stock bottomed out at $276.96 on Sept. 26, 2022, before beginning to recover. That was less than two weeks after the company announced it intended to buy competitor Figma.
Some of that recovered price faded away when investors—and later, American and European regulators—came out against the acquisition. Figma’s design software competes with Adobe’s XD, thus raising fears the deal would stifle innovation or lead to consumer price increases. Adobe is challenging that view.
If Adobe were to satisfy the regulators and finalize the deal, then the road to nearly doubled earnings would be somewhat easier. But what are the odds the company can push its EPS without NRI up to nearly $20 a share by the end of 2025?
Count Bill Nygren (Trades, Portfolio) of the Oakmark Fund as an optimist when it comes to Adobe’s overall potential. Writing in the fund’s fourth-quarter 2022 commentary, the guru noted:
“We invested in Adobe after the stock traded near a three-year low in the wake of the announcement that it would acquire Figma, a complementary design software vendor, for $20 billion. Despite the market’s fears related to this transaction, we believe that Adobe is a fast-growing, high-margin business that continues to possess enduring competitive advantages. Its Creative Cloud is the de facto standard for both professionals and students, and its Acrobat products are used to read and create billions of PDF documents every year.”
Nygren added that Adobe had successfully transitioned from selling licenses to cloud-based subscriptions.
From a financial strength standpoint, the company has a solid balance sheet, leaving no concern about potential distress. One indicator of that strength is its interest coverage ratio of 54.45, meaning it generates $54.45 in operating income for each dollar of interest expense. That is backed up by high Altman Z-Score of 9.6 (well into the safe zone, which means it is in good standing).
It is highly profitable and has delivered black ink every year for the past decade. And, those profits have been industry-leading, with an operating margin of 34.64% and a net margin of 27.01%.
Shareholders have enjoyed significant rewards, with return on equity at 33.50% and return on invested capital at 19.59%.
The news is equally robust on the growth front, with revenue growing by an average of 18.10% per year over the past three years and 20.90% over the past five years. The Ebitda growth rate is faster, at 20.90% per year over the past three years and 25.10% over the past five years.
Although the EPS without NRI numbers have faded off in the past two years, Adobe has enjoyed very rapid growth over the past decade, an average of 35.69% per year.
Just to round out the high-performance growth stats, we have free cash flow also well into the double digits.
Adobe does not pay a dividend, but has been buying back shares; over the past decade, it has averaged an annual reduction of 0.73%.
As we saw in the 10-year price chart, shares have fallen by about half over the past year and three months. That is a strong suggestion it is currently undervalued.
But there are other measures we can use to confirm or deny that thesis. The GF Value Line considers it to be significantly undervalued, placing an intrinsic value of $656.18. That is well above the current price of $322.32 and tells us there is a margin of safety.
The price-earnings ratio, though, is 31.91, which is above the software industry median of 26.68. Dividing that price-earnings ratio by the five-year Ebitda growth rate of 25.10% gives us a PEG ratio of 1.27, well within the fair valuation range.
We can have confidence in the discounted cash flow calculator since Adobe has a predictability rating of four out five stars. DCF, too, considers the current price to be a fair valuation, although it is based on an EPS without NRI growth rate of 20% per year. That is quite a bit less than the company’s actual growth rate of 35.70% per year over the past decade.
Overall, I am inclined to believe the company is fairly valued to significantly undervalued given its earnings power.
Adobe is very widely held among the gurus; 25 of them had stakes in the company at the end of 2022, according to 13F filings. The three largest holdings were those of PRIMECAP Management (Trades, Portfolio) (6,341,673 shares), Ken Fisher (Trades, Portfolio) of Fisher Asset Management (5,070,299) and Chuck Akre (Trades, Portfolio) of Akre Capital Management (1,239,558).
Institutional ownership comes in at 66.42% and insiders own 0.35%.
Investors should be aware that 13F filings do not give a complete picture of a firm’s holdings as the reports only include its positions in U.S. stocks and American depository receipts, but they can still provide valuable information. Further, the reports only reflect trades and holdings as of the most-recent portfolio filing date, which may or may not be held by the reporting firm today or even when this article was published.
Conclusion
Could Adobe really double its earnings in the next three years? Yes. As we have seen, the company has grown its EPS without NRI by an average of 35.70% per year over the past decade. Doubling would require only 24% per year. If that happens, then it is quite likely the share price will follow, giving investors some very rewarding capital gains.
