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Why Adobe Is One of the Best Software Stocks Around

Digital transformation is sweeping across the globe, and the pressure on companies to update their customer experiences for the 21st century is on the rise. Despite ample competition, there is plenty of new business to go around. However, after yet another quarterly performance that exceeded expectations, digital content creation software provider Adobe (NASDAQ: ADBE) has proven it is a best-in-breed pick.

Building another year of huge growth

Adobe's second-quarter revenue rose 25%, building on the same rate put up during the fiscal 2019 first quarter and topping management's guidance. Full-year expectations for $11.15 billion in revenue was left unchanged -- a 23% annualized increase -- and third-quarter revenue results were forecast to be up 22%. Adobe does tend to under-promise and over-deliver, so investors were more than happy to focus on the first half of the year's results.

Metric

Six Months Ended May 31, 2019

Six Months Ended June 1, 2018

YOY Change

Revenue

$5.35 billion

$4.27 billion

25%

Gross profit margin

84.9%

87.4%

(2.5 p.p.)

Operating expenses

$3.10 billion

$2.33 billion

33%

Adjusted earnings per share

$3.54

$3.21

10%

Data source: Adobe. YOY = year over year. P.p. = percentage point.

Though gross profit margins declined as Adobe added new services aimed at digital commerce -- primarily through its big takeover of Magento and Marketo last year -- the metric was still near a lucrative 85% rate. That's substantially higher than some of Adobe's software peers like salesforce.com (at 75.5% gross profit margin in its last quarter) and Shopify (at 56.3% gross profit).

With global digital change still a huge opportunity in front of it and growth well into the double digits, Adobe is keeping its foot on the gas. Operating expenses were up 33% in the first half of 2019, led by an increase in sales and marketing expenses to $1.63 billion. The higher expenses were the primary reason that adjusted earnings were up only 10% so far this year, handily trailing the top-line growth rate.

Image source: Getty Images.

Not for the thrifty, but worth paying up

Adobe is nevertheless a very profitable enterprise, and though the software company's bottom line isn't growing as fast as one might expect, the company's reinvestment back into itself will pay off later. With gross margins some of the best out there, growing sales as quickly as possible is a worthy cause.

That viewpoint shows up in the stock's valuation, currently priced at 53.9 times trailing-12-month earnings. That's a lofty valuation, but adjusting the metric using 12-month free cash flow (money left over after basic operating expenses and capital expenditures) yields a more reasonable 36.6. Plus, the expectation is that Adobe's growth will soon start paying off -- forward price to earnings is substantially lower than either of the trailing 12-month metrics and is currently at 29.7.

By any count, Adobe isn't cheap. But the leader in digital content creation is successfully parlaying that dominance into growth in commerce and other digital tools. North of 20% revenue expansion is in the cards for the foreseeable future, and combined with one of the best gross profit margins in the software business should equate to a big payoff down the road.

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Nicholas Rossolillo and his clients own shares of Salesforce.com and Shopify. The Motley Fool owns shares of and recommends Salesforce.com and Shopify. The Motley Fool recommends Adobe Systems. The Motley Fool has a disclosure policy.


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