Adobe (NASDAQ: ADBE) stock seems to have many more bulls on its side than bears. The software giant is up over 50% through mid-September this year, easily beating the 13% gain in the S&P 500. Those returns put it ahead of bigger peers like Microsoft, which is also benefiting from lots of Wall Street optimism.
There are two sides to every stock trade, though. For every buyer that’s banking on market-thumping returns, there’s a seller who has come to the opposite conclusion. With that debate in mind, let’s look at the key factors supporting the bullish and bearish readings on Adobe stock right now.
Bears see a few major risks involved with investing in Adobe stock. The clearest one is overpaying for this software-as-a-service (SaaS) business.
Adobe is priced at nearly 13 times annual sales today, putting its valuation higher than both Microsoft and Palo Alto Networks, the cybersecurity specialist. Investors have to pay a big premium when it comes to earnings as well. Adobe shares are valued at 46 times the past year’s profits, compared to Microsoft’s P/E ratio of 33.
That’s a steep price to pay for a company that’s only expected to boost sales by 10% this year. Most Wall Street pros are projecting 19% growth for Palo Alto Networks and an 11% increase for Microsoft.
Baked into those valuation figures are high expectations around what Adobe could achieve in the next few years by boosting the value of its digital content and cloud services platform. There’s a huge buzz around generative artificial intelligence (AI), for example, and this bullishness could set shareholders up for disappointment if AI fails to live up to the significant hype.
Bulls will counter that few companies are better positioned to take advantage of generative AI than Adobe. The recently launched Firefly product has been a massive hit, with users generating 2 billion images in the past six months. There are also dozens of less flashy ways that AI is adding value to products like Photoshop and Premiere Pro. These improvements are creating more excitement around the entire platform, and subscription revenue was up a healthy 13% in the most recent quarter.
Adobe is also highly profitable and has had no trouble monetizing its SaaS platform. Operating margin is a respectable 34% of sales, just below Microsoft’s industry-leading 40%. Annual fee cash flow has roughly doubled since 2020 to approach $5 billion this year.
Management has directed those resources mostly toward growth initiatives like AI, but there’s also been plenty of cash left over for direct shareholder returns in the form of stock buybacks. This metric is likely to rise along with Adobe’s stellar cash flow in the coming years.
Still, there’s no denying that the stock looks expensive, even considering Adobe’s strong finances and encouraging growth prospects. Investors risk seeing weak returns if they pay too much for this successful business.
That’s why the prudent approach might be to keep this software stock in your watch list for the next time a market downturn brings more discounts to the tech industry. The bulls and bears both have some good points when it comes to the pros and cons of investing in Adobe right now.
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Demitri Kalogeropoulos has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Adobe, Microsoft, and Palo Alto Networks. The Motley Fool recommends the following options: long January 2024 $420 calls on Adobe and short January 2024 $430 calls on Adobe. The Motley Fool has a disclosure policy.
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