Adobe (ADBE) is a bit of a sleeper Technology stalwart. It is a little lower beta than a lot of its peers and it may not have all the glitz and glamour of some companies that catch the market’s eye, but this firm is a financial juggernaut with a unique and endurable competitive advantage. Of course, we are renting the stock with a trade, but part of our current strategy at Punk Rock Traders is to use leveraged bets on quality companies.
But we always have a strategy. Donald Trump’s resounding victory removed a lot of uncertainty associated with volatility and the election, but it also introduced uncertainty with regard to the consumer. Tariffs, for instance, are regressive and reduce the consumer’s spending power. Adobe is a large enterprise company that primarily depends on corporate budgets for its revenues. It is thus somewhat insulated from a declining consumer.
And earnings show that corporate America is very strong. The firm had a kitchen sink quarter in September, but I think seasonal tailwinds could help lift this firm back up to 52-week highs before the year is over. I also think it could beat the tepid guidance it offered last quarter.
The company has an extensive product ecosystem that is nearly ubiquitous and has very high switching costs for its legions of customers. The firm is also a stealth AI play. It has a respectable suite of tools that help its users with productivity. It is one of the most important companies for the use and distribution of unstructured data and it has a vast network of loyal customers that helps attract new customers.
Furthermore, over the company’s extensive history it has proven an ability to make accretive acquisitions like in the area of cloud. It may surprise you to find out the Adobe has a comparable Return on Invested Capital to Apple. It actually also has a superior Return on Assets when compared to Cupertino.
As you can see Adobe has comparable fundamentals to Meta and Google, not bad company to be in. It can clearly hang with the big boys in terms of metrics that indicate management is able to deliver value consistently over time to shareholders. Adobe is a $200 billion company that is consistently putting up double digit growth. Like many of our trades, we are getting into Adobe early in anticipation of a rise in the implied volatility of options contracts as the uncertain event approaches—earnings in this case.
Despite the tepid guidance last quarter, you can see the firm is maintaining double digit growth across different segments. This gives it a breadth of earnings strength that some Technology companies lack. Furthermore, the firm has considerably superior profitability metrics when compared to peers. For example, the firm’s cashflow margin dwarfs its primary competitors.
In terms of valuation, the firm is a mixed picture. Stalwart technology firms with a proven endurable competitive advantage tend to fetch valuation premiums, and Adobe is no different. However, when you dive into the valuation under the hood, there’s a lot to like after the company’s earnings stumble in September. Adobe is a seasoned firm with capable management, and I’m betting that economic strength which came in above many expectations will lead them to beat what may end up looking like a sandbag quarter.
The firm is lower beta stock than many Tech peers. Slow and steady wins the race. Still, as you can see above, the firm tends to have some pretty positive reactions to earnings in the last eight quarters. In terms of valuation, the firm is overvalued with both a 5 year and 10 year discounted cashflow, but when you use EBITDA, you can see the economic potential of the firm is considerable.
The other thing is that despite a considerable competitive advantage and a proven past of delivering shareholder value through leading edge acquisitions, the firm remains relatively undervalued when compared to a lot of its peers, many of whom are inferior on most financial metrics when compared to Adobe. When you analyze the firm in terms of relative valuation, the implied upside is even greater.
Adobe is a company that benefits from other strong companies. COVID cleared a lot of the deadwood amongst America’s commercial entities, and we are seeing continued earnings strength and corporate resilience. I think the strong economy and a strong competitive advantage will allow this company to thrive in the last and strongest quarter of the year.
So here is the trade. I want to get a little bit out of the money, but not much.
Buy the January 17th, 2025 call options on $ADBE at $515. They last traded at $2,800.
Do not sell these until at least earnings in early December.
Put tight stops on them if you are more risk averse.
