Adobe ADBE Stock - Time To Power Up Excel!!!

Key Concepts

• Stock-Based Compensation (SBC): Non-cash compensation that the author argues should be treated as a real expense, criticizing the reliance on non-GAAP earnings.
• Annualized Recurring Revenue (ARR): A metric used by Adobe to track subscription growth, which the author interprets as a sign of pricing pressure rather than pure user growth.
• Intrinsic Value: The calculated fair value of a stock based on discounted future earnings, growth rates, and terminal multiples.
• Margin of Safety: An investing principle where an investor only buys when the market price is significantly below the intrinsic value to minimize downside risk.
• Dilution Rate: The annual percentage increase in shares outstanding, which the author notes is approximately 3% for Adobe.

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1. Business Analysis and Performance

Adobe’s business model, spanning products like Acrobat, Creative Cloud, Photoshop, and Firefly, is currently facing a period of deceleration. While revenue is growing in the low double digits, earnings per share (EPS) growth is stagnant at approximately 8%.

• Management Turnover: The departure of both the CEO and CFO is highlighted as a significant "question mark" regarding the company's future stability.
• Competitive Landscape: The author notes that Adobe is facing intense competition from newer, more streamlined tools that offer "all-in-one" solutions, potentially causing Adobe to lose market share.
• Pricing Pressures: The shift in focus from user growth to ARR is interpreted as a sign that Adobe is struggling to grow its user base and is instead relying on price increases to maintain revenue growth.

2. The "Non-GAAP" Controversy

The author strongly criticizes Adobe’s use of non-GAAP earnings, which exclude stock-based compensation.

• The Buffett Perspective: Citing Warren Buffett, the author argues that if compensation is not an expense, it is misleading to investors.
• True Cost of SBC: The author calculates that Adobe spends roughly $2 billion annually on SBC. When factoring in the 3% annual dilution rate, the "true cost" to keep the share count stable is significant, often negating the benefits of the company's share buyback programs.

3. Valuation and Scenarios

Using an intrinsic value model, the author evaluates Adobe under three distinct scenarios:

• Normal Case: Assuming 8% growth for five years and 6% thereafter, with a 10% discount rate and a P/E of 15, the stock is considered "fairly priced" for a 9–10% return.
• Best Case: Assuming 12–13% growth and a terminal P/E of 20, the stock would need to double to provide a 10% return, suggesting higher upside potential if growth targets are met.
• Worst Case (Margin of Safety): Assuming a 4% growth rate followed by a 4% decline, the stock could potentially drop another 65% from current levels. The author concludes that this scenario makes Adobe too risky for their personal portfolio.

4. Investment Strategy and Perspectives

• The Michael Burry Thesis: The author acknowledges that Michael Burry has taken a "full position" in Adobe, likely based on the fact that the price-to-sales ratio is at decade lows. However, the author warns that Burry’s strategy relies on a portfolio of several "full positions" where only a few need to succeed to offset losses.
• Recession Risk: The author highlights that Adobe has not faced a recession in 17 years. In a recessionary scenario where earnings drop from $17 to $10 and the P/E contracts to 12, the stock could face an additional 40% downside.
• Comparative Analysis: When compared to Microsoft, the author suggests that Microsoft offers a better valuation and a more stable investment profile, making it a potentially better candidate for a diversified portfolio.

5. Synthesis and Conclusion

The author classifies Adobe as a "bet" rather than a core holding. While the company remains a dominant player in the creative and marketing software space, the combination of decelerating growth, management turnover, and the "hidden" costs of stock-based compensation creates a risk profile that does not provide a sufficient margin of safety. Investors are encouraged to view Adobe through the lens of their own risk tolerance and consider whether other large-cap tech stocks, such as Microsoft, offer better fundamental value.