Adobe (NASDAQ:ADBE): A very Profitable Company now Trading at a Reasonable Price

Adobe ( NASDAQ:ADBE ) is due to report fourth quarter financial results before the market opens on Thursday. The stock price has fallen as much as 15% in recent weeks, which, assuming no negative surprises, could be an opportunity. Adobe has topped earnings estimates for the last 11 consecutive quarters, and revenue estimates for the last five consecutive quarters. However, the focus is likely to be on guidance for 2022, as it has for other software companies. 

Fourth quarter analyst estimates:

• Normalized EPS: $3.20, up 52% YoY
• GAAP EPS: $2.53, down 45% YoY (due to an income tax expense in 4Q20)
• Revenue: $4.09 bln, up 19% YoY

Adobe has been caught up in the wholesale selling of software growth stocks over the last month. This selling may have been overdone, as Adobe appears to have been lumped together with companies with low or negative margins. However, with its enviable margins, Adobe actually compares favorably with the likes of Apple, Microsoft, and Alphabet - the companies that have performed best in recent weeks. In addition, Adobe is also now trading at a small discount to our estimates of it’s fair value , for the fisrt time this year.

Adobe's Growth Potential

To get an ideas of Adobe’s long term earnings growth potential we can have a look at its return on capital employed (ROCE). Ideally we want to see a growing return on capital employed and then alongside that, an ever-increasing base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. 

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business.Analysts use this formula to calculate it for Adobe:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.28 = US$5.5b ÷ (US$26b - US$6.2b) (Based on the trailing twelve months to September 2021) .

Thus, Adobe has an ROCE of 28%. In absolute terms that's a great return and it's even better than the Software industry average of 11%.

See our latest analysis for Adobe

In the above chart we have measured Adobe's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Adobe .

What Does the ROCE Trend For Adobe Tell Us?

We like the trends that we're seeing from Adobe. The data shows that returns on capital have increased substantially over the last five years to 28%.The amount of capital employed has increased too, by 102%.The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.

Our Take On Adobe's ROCE

To sum it up, Adobe has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific.And a remarkable 481% total return over the last five years tells us that investors are expecting more good things to come in the future.In light of that, we think it's worth looking further into this stock because if Adobe can keep these trends up, it could have a bright future ahead.

One more thing, we've spotted 1 warning sign facing Adobe that you might find interesting.

High returns are a key ingredient to strong performance, so check out our free list of stocks earning high returns on equity with solid balance sheets.

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Simply Wall St analyst Richard Bowman and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.