Adobe (NASDAQ:ADBE) stock — alongside essentially every other large-cap tech stock in the market — has plunged in September, with shares falling as much as 13% in just three weeks.
Although that may seem like a big sell-off. But context is important here. Coming into September, ADBE stock was up 60% year-to-date. Even after this recent plunge into correction territory, shares are still up more than 40% in 2020.
Contextualizing the recent sell-off in ADBE stock, in this way allows us to more rationally see it as nothing more than a minor near-term drawback in a longer-term uptrend.
To that extent, near-term weakness in Adobe stock is little more than a longer-term buying opportunity, mostly because:
- The mass enterprise digitization wave — of which Adobe is at the epicenter of — is still underway, and will re-define corporate spending and investment behavior over the next decade.
- Enterprise discretionary spending is rebounding, and will continue to rebound over the next few quarters, sparking a re-acceleration in Adobe’s top-line growth rates.
- Adobe stock is attractively undervalued considering the company’s favorable long-term growth prospects.
So, buy the dip in ADBE stock.
Here’s a deeper look.
Mass Enterprise Digitization
The Covid-19 pandemic has forced every enterprise of every shape and size, from every industry and geography, to digitize.
This mass digitization wave will re-define corporate spend and investment over the next decade, as companies continue to embrace the digital economy and the make the shift towards becoming faster, more efficient digital-first organizations.
Adobe provides various top-tier products and services which will help facilitate this transition.
The company’s Creative Cloud solutions will help organizations create more digital and visual media products, services and marketing campaigns, as their customers learn about and engage with their products more and more through digital funnels.
Adobe’s Document Cloud solutions will help organizations in their paper-to-digital transformations, making pens and papers obsolete, and turning digital document management processes into a ubiquitous reality.
The Experience Cloud will help organizations build robust digital CX ecosystems through various AI-driven, digital-first marketing, advertising and commerce solutions.
All in all, demand for Creative Cloud, Document Cloud and Experience Cloud solutions will boom amid the mass enterprise digitization wave that is rippling across the world, and will continue to ripple across the world for the next few years.
As that happens, Adobe will sustain robust revenue and profit growth — and ADBE stock will keep charging higher.
Rebounding Enterprise Discretionary Spend
Boosting Adobe’s growth narrative over the next few quarters will a rebound in discretionary enterprise spending.
However, it’s no secret that businesses cut back spending amid the Covid-19 pandemic. Because Adobe is built on the back of enterprise spending, this dynamic showed up in Adobe’s numbers. Coming into the year, Adobe was consistently reporting 20%-plus revenue growth. Over the past two quarters, revenue growth has hovered around 14%.
But, over the next few quarters, discretionary enterprise spending will rebound, as consumer behavior and economic activity both normalize. This rebound in discretionary spend will couple with the aforementioned mass digitization wave to spark a return in Adobe’s revenue growth rates to 20% level in 2021.
Optically, that’s a great thing. As revenue growth rates rebound from ~14% today back to ~20% over the next few quarters, it’s easy to see investors piling into ADBE stock.
Adobe Stock is Undervalued
The biggest reason to buy ADBE stock on the dip is that the stock is undervalued relative to the company’s robust long-term growth prospects.
Thanks to secular demand tailwinds and the company’s huge addressable market which management pegs at roughly $130 billion, Adobe reasonably projects as a 10%+ revenue grower for the next several years.
At the same time — by virtue of being a software business with very little formidable competition across its three major operating verticals — Adobe will continue to benefit from big gross margins (~90%) and tons of positive operating leverage with increased scale. Of course, that means profit margins will continue to expand for the foreseeable future.
This combination of 10%+ revenue growth and profit margin expansion paves the path for Adobe to grow earnings at 15%+ clip for the foreseeable future.
My modeling suggests that Adobe will net $20 in earnings per share by fiscal 2025.
Application software stocks like Adobe normally trade around a forward earnings multiple of 35.
That sector-average multiple on $20 in 2025 earnings per share implies a 2024 price target for ADBE stock of $700. Discounted back by 8.5% per year, that implies a 2020 price target for the stock of just over $500.
Bottom Line on ADBE Stock
Don’t overcomplicate things.
Adobe stock is a long-term winner, and nothing that has happened in September changes that fact.
So, buy the dip with the stock down in correction territory.
On the date of publication, Luke Lango did not have (either directly or indirectly) any positions in the securities mentioned in this article.
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