After tech stocks ended 2018 on a treacherous note, the new year has brought renewed prosperity to the sector. Software stocks in particular are rallying.
Adobe Systems (NASDAQ:ADBE) is no exception. From its recent low of $205 per share, the Adobe stock price is back up to $258. That puts ADBE stock within striking range of its all-time high price of $277.
Across the sector, investors are chasing stocks to fresh new heights. On Monday, a variety of cloud and software plays hit 52-week or all-time highs. Among the names in that category were Shopify (NYSE:SHOP), Coupa Software(NASDAQ:COUP), Smartsheet (NYSE:SMAR), Atlassian (NASDAQ:TEAM), Workday (NASDAQ:WDAY), and VMware (NYSE:VMW), among others.
So Adobe stock should be going up, since the sector is on fire. Adobe’s recent strong performance has little connection to its own particular fundamentals. And given the hotness of the tech sector, savvy traders should consider selling tech stocks and taking profits at this point.
For Adobe, 2018 Was a Great Year
Adobe has delivered impressive growth in recent years, and that trend continued in 2018. Rather remarkably, the revenue increases of both major Adobe business units were almost equal. The company’s Digital Media unit, which accounts for roughly a third of its revenue, generated top-line growth of 27%. The sales of Adobe’s core Digital Media business, which accounts for around 70% of Adobe’s revenues, increased by 26%. With the revenue of both major divisions increasing more than 25% annually, the company is clearly doing well.
You may have seen some griping about Adobe’s last earnings report of 2018. The company’s earnings per share did come in below analysts’ consensus estimate, but its revenue came in above the consensus outlook. The earnings shortfall was due to costs related to Adobe’s acquisition of Marketo. In the long-run, a near-term earnings miss due to M&A won’t affect the company’s outlook meaningfully.
What is important is that Adobe is no longer just the world’s best image-software company; it now offers a broader business solutions package. Adobe purchased both Marketo and Magento recently. Marketo does B2B marketing while Magento offers digital-marketing solutions. By offering its customers a rich suite of software solutions, Adobe has gained many synergies.
Adobe’s revenue jumped nearly 25% last year. Probably not coincidentally, Adobe stock rallied 29% in 2018. Investors tend to price a company like Adobe based on its sales, so it makes sense that ADBE stock rose during a year in which its revenue surged. However, the situation could change in 2019.
Adobe Stock Is Expensive
Those who are bearish on ADBE stock can point out an obvious, if true, statement: Adobe stock is really pricey. On a trailing basis, Adobe stock has a price-earnings ratio of 50. Now, to be fair, ADBE had some one-tine costs in 2018. But the company’s forward P/E ratio stands at 27. That’s still quite pricey, especially since analysts have already baked healthy growth into their 2019 projections.
On a price-sales basis, ADBE stock looks even more expensive. It is currently going for more than 14 times its sales. The normal rule of thumb for fast-growing tech stocks is that they are valued fairly if they’re trading at ten times their sales.
Consider that even if Adobe’s revenue jumps 24% again in 2019, it will still be selling for a touch over ten times its sales. Various peers of Adobe are selling for between eight and ten times their sales at the moment, suggesting that Adobe stock price could drop considerably if the valuation of ADBE stock drops to levels that are more in-line with the rest of the tech sector.
How Much Can the Experience Cloud Grow?
The big question for ADBE stock, at least for long-term investors, is how far its so-called experience cloud can run. After integrating Marketo, Magento, Tubemogul, and other acquisitions, Adobe is now seen as a leader in the still-emerging marketing-cloud space. As is often the case in tech, Adobe’s first- mover advantage in that area appears to be huge.
Bulls are buying up Adobe stock because of their belief that the company will become the entrenched leader in the space. Even so, it’s worth asking just how much that achievement would be worth. Consider that the shares of the current leader of the marketing-software space, Salesfore.com (NYSE:CRM), are selling for just 9.5 times its sales.
Adobe stock would have to drop around 30% to reach Salesforce’s valuation. And Salesforce isn’t exactly considered a value stock ,either. Salesforce has posted average annual revenue growth of 28% over the past five years, and analysts don’t expect that to change much. Does Adobe stock deserve such a large premium over Salesforce’s shares?
The Verdict on Adobe Stock
Given the great enthusiasm we are seeing for tech and software stocks, it seems tempting to hold Adobe stock into its earnings which are slated to be announced next month. However, I’d urge investors to be cautious about ADBE stock. Much of the recent gains of Adobe stock price have been triggered by the rallies of other cloud names.
But Adobe still has to prove its own merits. Analysts will be looking at the company’s M&A costs closely. And with 25% revenue growth already baked into investors’ expectations, Adobe stock may not have all that much room to advance further even if its numbers are relatively strong.
With tech stocks on fire, it seems like a good time to take some chips off the table, whether we’re talking about ADBE stock or other names in the sector that are making fresh, new all-time highs.
At the time of this writing, Ian Bezek held no positions in any of the aforementioned securities. You can reach him on Twitter at @irbezek.
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