Adobe - A Fundamental and Historical Valuation

💳 Business Overview

🎯Key Metrics

Total: 9/17

• +2 ✅✅ Projected Operating Margin: 46.04%
• +0 ⚠️ Projected 5-Year Revenue CAGR: 8.69%
• +2 ✅✅ Last 5-Year ROIC: 28.00%
• +1 ✅ Estimated Cost of Capital: 10.31% (lower than ROIC)
• +1 ✅ Last 5-Year Shares Outstanding CAGR: -2.32%
• +1 ✅ Projected 5-Year EPS CAGR: 10.67%
• +0 ⚠️ Projected 5-Year Dividend CAGR: N/A
• +1 ✅ Moody's Rating: A1
• +2 ✅✅ Morningstar Moat: Wide
• -1 ❌ Morningstar Uncertainty: High

Adobe has very high margins resulting from its competitive advantages and wide moat. Also, the company is managed well returning on its investments almost triple its cost of capital. Its revenue and EPS growth are also solid around the ~10% mark.

However, there may be clouds on the horizon for Adobe. It may suffer from the AI revolution or its growing competition (ex. Canva). This is indicated on the High Uncertainty rating by Morningstar.

Let's go over to the next section to see if the risks of disruption can be counter balanced by its current valuation.

📈Business Valuation

To calculate the intrinsic value of the company I'll use multiple methods:

• Discounted Cash Flows (DCF) - Intrinsic value is estimated by projecting its free cash flows over the next 10 years and discounting them to present value;
• EPS Growth - the fair value is estimated by projected the Earnings Per Share CAGR for the next 5 Years and then, given its current and historic values of PE, come up with a PE for the 5th Year. This will give us its price 5 Years from now using the formula: Price = EPS x PE that we then discount using the estimated cost of capital;
• Historical P/S - we assume mean reversion to the historical PS values;
• Historical P/E - we assume mean reversion to the historical PE values;
• Historical EV/EBITDA - we assume mean reversion to the historical EV/EBITDA values;
• Historical P/CF - we assume mean reversion to the historical P/CF values;

I'll give more weight to the DCF and EPS methods, and only then the historical ones. Giving the changing landscape of the world in general and the probability of disruption of the company, we should not assume that mean reversion to historical values is guaranteed.

Cost of Capital

I've used the latest financial statements of the company, the 10-Year US bonds as the risk free rate, the company Moody's rating and revenue geographic exposure to come up with its cost of capital, cost of debt and cost of equity.

Cost of Capital: 10.31%.

This value will be used later as a discount rate in the valuation methods.

Please feel free to come up with your own values by using the tool I've used: Cost of Capital - The Fair Value Journal. It is and will ever be completely free :)

Discounted Cash Flows (Weight: 30%)

I've used the latest and annual financial statements of the company, the analyst estimates for both revenue and margins and the cost of capital calculated previously.

Some notes on the inputs above:

• Terminal Revenue Growth - I'm using the risk-free rate (10-Yr bonds of US), because long term the company should not grow more than the rate of the economy. I'm using the risk-free rate as a proxy to it, so the terminal growth becomes it;
• Terminal Cost of Capital - I'm assuming that the company starts at the previously estimated cost of capital and then will converge gradually to the average cost of capital of its industry;
• Terminal Tax Rate - It's the same as the terminal cost of capital, starts at its current and historical average values and over time becomes the same as the industry.

All the other inputs were taken or from the financial statements or from analyst projections.

The DCF gives us an estimated fair value of 346.19 dollars for Adobe.

Something that we can also do now is to play around with Monte Carlo simulations. What this will allow us to do is to simulate multiple DCF valuations with pre-defined ranges for each of the inputs. Each simulation will randomize the inputs between these pre-defined values. For this I also used analysts estimates.

As you can see from the above Adobe seems to be undervalued because even on the lower end of the simulations (P10) its DCF estimated fair value is still high compared to the current company's price.

Given the fact that its current price is below P10, we can extrapolate that there's 90% probability that the stock is undervalued. Always with a grain of salt because this is only one valuation method, let's continue with the next ones, to get a clearer picture.

Please be free, as before, to fill in your own values. Make the valuation your own and do yourself a DCF valuation using your own assumptions: DCF - The Fair Value Journal

EPS Growth (Weight: 20%)

For this valuation method, I've used the current EPS and the analysts estimates of EPS growth. I also assumed a 20 PE for Adobe given its recent history but please note that for me this is probably very modest for the industry, metrics and overall growth presented by Adobe.

Then again, I used the Monte Carlo simulations to check how the estimated fair value changed as my assumptions were modified.

Also, using this valuation method, Adobe that is currently priced at 304.44 dollars, seems to be undervalued, being currently valued well below P10. A situation in line with what we've seen on the DCF valuation. We can extrapolate that, given the EPS Growth valuation, there's a 90% probability of Adobe being undervalued.

Despite this, let's continue with the following valuation methods to get an even clearer view of its valuation.

As before, feel free to try this yourself: EPS Growth - The Fair Value Journal

Historical P/S (Weight: 15%)

The current Price To Sales (P/S) ratio is below its 7-8 Year average. This means that the company is undervalued by this metric. Assuming a mean reversion to its historical norm of 12.96 we can assume a fair value of 481.08 dollars.

Please keep in mind the disruption that the company may suffer. That is one of the reasons this historical methods may overvalue the company.

For every type of historical and relative valuation you can use the same free tool: Historical / Relative Valuation - The Fair Value Journal .

Historical P/E (Weight: 15%)

The current Price To Earnings (P/E) ratio is below its 7-8 Year average. This means that the company is undervalued by this metric. Assuming a mean reversion to its historical norm of 43.37 (very high in my opinion) we can assume a fair value of 478.67 dollars.

Historical EV/EBITDA (Weight: 10%)

The current EV/EBITDA ratio is below its 7-8 Year average. This means that the company is undervalued by this metric. Assuming a mean reversion to its historical norm of 32.58 we can assume a fair value of 481.53 dollars.

Historical P/CF (Weight: 10%)

The current Price To Cash Flow (P/CF) ratio is below its 7-8 Year average. This means that the company is undervalued by this metric. Assuming a mean reversion to its historical norm of 31.05 we can assume a fair value of 482.58 dollars.

✍️Summary

Now that we did all the heavy work, let's take the above and come up with the company weighted average fair value.

I basically take each valuation method used and given my confidence on the company apply a 20% or 10% discount (when to buy) and addition (when to sell) or use the Monte Carlo P10, P20, P80 and P90 values:

Feel free to choose your own values, but for me I'll take a fair value of 356.98 dollars for Adobe given the current uncertainty around the company.

Please remember that the fair value estimate has a 100% probability of being wrong and it will never be a precise number, even if it has decimals next to it 😮

However, overall, Adobe seems to be undervalued in almost every way you look at it, providing you a good opportunity to have this wide moat business in your portfolio.

Fair Value: 356.98 dollars