Adobe Systems Incorporated (NASDAQ:ADBE) is most widely known for its Adobe Reader software, but the company’s other offerings have been built into a $16 billion market cap business. So far this year the stock has moved about in line with the NASDAQ index, though over the past month or so it has slightly underperformed and is now up 15% for the year compared to the index’s gain of about 20%.
Product revenue, Adobe Systems Incorporated’s largest source of business, was flat in the company’s most recent quarter (ending in August) compared to the same quarter in 2011, but subscription revenue was up and drove a moderate revenue rise of 7%. As a result, net income was up slightly. Due to higher costs in the first half of Adobe’s fiscal year (the company has a November year end), the first nine months of the year actually showed a decline in earnings, and a fall in earnings per share from $1.30 to $1.22.
Adobe’s trailing price-to-earnings multiple is 21. The software industry includes companies at a broad range of earnings multiples, but we would have to say that the company will have to do better on the earnings front, including turning in fiscal years that improve on the previous year, in order to justify its current valuation. Wall Street analysts expect improvement in the company’s business, and so Adobe’s forward earnings multiple is only 14.
Adobe Systems Incorporated was the second largest position in ValueAct Capital’s portfolio at the end of June; the fund, managed by Jeffrey Ubben, owned 31 million shares of the stock giving it a stake worth over $1 billion at that time (find more top stocks from ValueAct Capital). ValueAct owns stocks for an average of three years, so our guess is that the fund is still a major investor. Christopher Lord’s Criterion Capital nearly doubled the size of its own position in Adobe over the course of the second quarter and reported 3.5 million shares in its 13F filing (see more stock picks from Criterion Capital).
Given the specific verticals in which Adobe’s software operates, we think that Intuit Inc. (NASDAQ:INTU), Microsoft Corporation (NASDAQ:MSFT), Oracle Corporation (NASDAQ:ORCL), and Apple Inc. (NASDAQ:AAPL) make for a good set of peers. Intuit has a lot in common with Adobe on a quantitative basis: its $17 billion market capitalization is close to Adobe’s $16 billion, and its trailing and forward P/Es are 23 and 16 respectively (indicating very similar implied growth rates). Intuit’s fiscal year ended in July with slightly lower earnings than expected, but the crucial quarter ending in April (the time of year when the maker of TurboTax and QuickBooks does the most business) slightly beat expectations. We think it should trade at a slightly higher multiple than Adobe, and it does; no pair trades here, then. Oracle is cheaper than Adobe at 16 times trailing earnings and 11 times forward earnings estimates. In addition, the sell-side expects better growth going forward from the company (its five-year PEG ratio, which puts the P/E in the context of the consensus growth rate in earnings, is 1, indicating fair value). Oracle did grow its earnings in its most recent quarter versus the same period a year ago, though this came entirely from margins as revenue showed a slight decline.
Microsoft and Apple made our list of the ten most popular stocks among hedge funds in the second quarter. These technology supermajors are also cheaper than Adobe: Microsoft’s trailing P/E is 15 (and that includes a hit to its earnings from a recent non-cash charge) while the rapidly growing Apple’s is 16. Apple’s forward P/E is 13, while Microsoft’s is 9; here Microsoft’s P/E is likely being skewed downward because of the impending release of the new versions of Windows and Office, which will temporarily push up net income. Based on this pricing we would have to consider either of these companies a better buy than Adobe.
