- By GF Value
The stock of Adobe (NAS:ADBE, 30-year Financials) appears to be modestly overvalued, according to GuruFocus Value calculation. GuruFocus Value is GuruFocus' estimate of the fair value at which the stock should be traded. It is calculated based on the historical multiples that the stock has traded at, the past business growth and analyst estimates of future business performance. If the price of a stock is significantly above the GF Value Line, it is overvalued and its future return is likely to be poor. On the other hand, if it is significantly below the GF Value Line, its future return will likely be higher. At its current price of $516.09 per share and the market cap of $246.7 billion, Adobe stock is believed to be modestly overvalued. GF Value for Adobe is shown in the chart below.
Because Adobe is relatively overvalued, the long-term return of its stock is likely to be lower than its business growth, which averaged 22.1% over the past three years and is estimated to grow 16.42% annually over the next three to five years.
Investing in companies with poor financial strength has a higher risk of permanent loss of capital. Thus, it is important to carefully review the financial strength of a company before deciding whether to buy its stock. Looking at the cash-to-debt ratio and interest coverage is a great starting point for understanding the financial strength of a company. Adobe has a cash-to-debt ratio of 1.05, which is worse than 68% of the companies in Software industry. GuruFocus ranks the overall financial strength of Adobe at 7 out of 10, which indicates that the financial strength of Adobe is fair. This is the debt and cash of Adobe over the past years:
Investing in profitable companies carries less risk, especially in companies that have demonstrated consistent profitability over the long term. Typically, a company with high profit margins offers better performance potential than a company with low profit margins. Adobe has been profitable 10 years over the past 10 years. During the past 12 months, the company had revenues of $13.7 billion and earnings of $11.49 a share. Its operating margin of 34.75% better than 97% of the companies in Software industry. Overall, GuruFocus ranks Adobe's profitability as strong. This is the revenue and net income of Adobe over the past years:
Growth is probably the most important factor in the valuation of a company. GuruFocus research has found that growth is closely correlated with the long term performance of a company's stock. The faster a company is growing, the more likely it is to be creating value for shareholders, especially if the growth is profitable. The 3-year average annual revenue growth rate of Adobe is 22.1%, which ranks better than 82% of the companies in Software industry. The 3-year average EBITDA growth rate is 27.1%, which ranks better than 73% of the companies in Software industry.
Another way to look at the profitability of a company is to compare its return on invested capital and the weighted cost of capital. Return on invested capital (ROIC) measures how well a company generates cash flow relative to the capital it has invested in its business. The weighted average cost of capital (WACC) is the rate that a company is expected to pay on average to all its security holders to finance its assets. We want to have the return on invested capital higher than the weighted cost of capital. For the past 12 months, Adobe's return on invested capital is 28.54, and its cost of capital is 7.55. The historical ROIC vs WACC comparison of Adobe is shown below:
In short, The stock of Adobe (NAS:ADBE, 30-year Financials) shows every sign of being modestly overvalued. The company's financial condition is fair and its profitability is strong. Its growth ranks better than 73% of the companies in Software industry. To learn more about Adobe stock, you can check out its 30-year Financials here.
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This article first appeared on GuruFocus.