Tuesday, February 21, 2023
It's no secret that I'm a big believer in cloud computing.
It's not simply because the global market for this technology – using Internet-hosted networks to store and manage data – is growing at nearly 16% a year and was worth $369 billion as of 2021.
It's because of something far more fundamental. You see, a well-run firm that uses the cloud to deliver Software as a Service ("SaaS") has two things that hardware companies only dream about...
The first is high profit margins. Software companies don't have to spend a lot of money on equipment and production.
The second is even better: recurring revenue. The money just rolls in month after month.
In an era of high inflation that can take its toll on earnings, these factors are very important.
Today, I want to reveal a large-cap company that's among the leaders in cloud computing. And to be sure it fits our criteria for investment, I'll run it through my five-part investment system...
My system takes emotion out of the equation and helps identify which companies can help us build true wealth.
As a creative professional, I've been following Adobe (Nasdaq: ADBE) for more than 30 years.
As a former musician, I've had artwork designed for my CDs and had photographs professionally edited and color corrected. And as a journalist, I knew that the software this company develops plays an integral role in desktop publishing.
Adobe is highly regarded for products like Illustrator, used to create and edit graphics, and Photoshop, which helps users manage and edit pictures.
In 2009, Adobe quietly began moving from a sales model to a de facto "rental" model. Users would pay monthly fees to gain access to a range of products delivered via the web, or "cloud."
In addition to the business model pivot, Adobe acquired privately held Magento Commerce in 2018 for $1.6 billion. That moved the company from a focus on digital content management only to e-commerce, too.
At the time of the deal, Magento said it handled more than $150 billion in gross merchandise volume. By contrast, that's nearly twice as much as eBay's (EBAY) $88.4 billion in 2017, according to data from FactSet.
For me, Adobe is an intriguing investment opportunity in the cloud-computing space. But how does it stack up against my five-part screening system? Let's take a look...
To start, we're looking for well-run firms with top-notch leaders. One way to spot these is by taking a look at key partners.
Adobe works closely with one of the world's biggest cloud-services firms, Microsoft (MSFT). In December 2022, the two announced a sweeping alliance. Adobe Experience Cloud and Adobe Document Cloud now integrates with Microsoft's Dynamics 365, Office 365, LinkedIn, and Azure cloud-infrastructure services.
This gives Adobe access to 180 million of Microsoft's commercial customers. And the company has said it's getting a "phenomenal response" for the Microsoft integration.
Remember that to create real wealth, you have to ignore the hype and find companies that have rock solid fundamentals.
The market's wild panic over the spread of the coronavirus hammered stocks across the board. But lost in all of that is the fact that Adobe is an incredibly well-run firm.
It has pre-tax profit margins of 44.8% and the exact same figure for return on stockholders' equity. Furthermore, it generates nearly $6 billion in free cash flow ("FCF") with net cash on hand coming in at $1.5 billion.
We aim to look for stocks in red-hot sectors, because they offer the best chance for life-changing gains.
Overall cloud sales are growing at more than 21% a year. At that rate, they're doubling about every three-and-a-half years. So Adobe has clearly focused on a market that is part of a long-term trend and one that could grow 10-fold by 2036.
Adobe's total addressable market is projected to reach $80 billion by the end of this year, a statistic that's more impressive than it initially sounds.
In 2009, the company had zero cloud sales. But in fiscal year ("FY") 2022, revenue totaled nearly $17.6 billion. Of that, recurring sales, basically cloud related, accounted for 93.2% of all revenues.
Companies that have the strongest growth rates almost always offer the highest stock returns.
Over the past three years, Adobe has grown its sales by an average of 17%, meaning sales are doubling roughly every four years. By the end of FY 2026, they could rise to $35.2 billion with high-margin cloud sales accounting for the vast majority.
Finally, this is where we look at a company's earnings growth and see how long it'll take it to double profits. By doing that, we can figure out how long, on average, it should take for the stock to double.
I'm projecting Adobe's earnings per share ("EPS") will grow by an average of 20% over the next three years.
Now let's use what I call my doubling calculator – mathematicians call it The Rule of 72. This is a way to estimate how long it might take for an investment to double, based on a given rate of return.
Simply put, by dividing 72 by a given annual rate of return, investors can get a rough estimate of how many years it will take for their investment to double.
In this case, let's divide Adobe's compound profit growth rate of 20% into the number 72. When we do that, we learn it should take about three-and-a-half years for earnings to double. And when earnings double, stock prices typically do, too.
With a market cap of $166 billion, Adobe's stock trades at $365 a share. Now is a great time to scoop up shares and add this wealth-building winner to your portfolio.
And for my "Pro" subscribers, I'll reveal another opportunity – an investment into the cloud-computing trend that's already up double digits since the start of this year. Don't miss it!
FOR TREND TRADER PRO READERS ONLY
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Cheers and Good Investing,
Chief Investment Officer
Trend Trader Daily