Advertisement
Australia markets open in 3 hours 29 minutes
  • ALL ORDS

    8,456.80
    +13.10 (+0.16%)
     
  • AUD/USD

    0.6716
    -0.0035 (-0.52%)
     
  • ASX 200

    8,187.40
    +10.50 (+0.13%)
     
  • OIL

    73.55
    -0.02 (-0.03%)
     
  • GOLD

    2,627.00
    -8.40 (-0.32%)
     
  • Bitcoin AUD

    90,769.37
    -1,703.60 (-1.84%)
     
  • XRP AUD

    0.79
    +0.00 (+0.09%)
     

Adobe Inc.'s (NASDAQ:ADBE) Intrinsic Value Is Potentially 37% Above Its Share Price

Key Insights

  • The projected fair value for Adobe is US$737 based on 2 Stage Free Cash Flow to Equity

  • Adobe's US$537 share price signals that it might be 27% undervalued

  • Analyst price target for ADBE is US$612 which is 17% below our fair value estimate

How far off is Adobe Inc. (NASDAQ:ADBE) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the forecast future cash flows of the company and discounting them back to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. There's really not all that much to it, even though it might appear quite complex.

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

See our latest analysis for Adobe

Is Adobe Fairly Valued?

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To begin with, we have to get estimates of the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

2025

2026

2027

2028

2029

2030

2031

2032

2033

2034

Levered FCF ($, Millions)

US$9.55b

US$10.8b

US$11.7b

US$13.1b

US$14.2b

US$15.1b

US$15.9b

US$16.6b

US$17.2b

US$17.8b

Growth Rate Estimate Source

Analyst x19

Analyst x9

Analyst x1

Analyst x1

Est @ 7.97%

Est @ 6.33%

Est @ 5.18%

Est @ 4.38%

Est @ 3.81%

Est @ 3.42%

Present Value ($, Millions) Discounted @ 6.7%

US$8.9k

US$9.5k

US$9.6k

US$10.1k

US$10.3k

US$10.2k

US$10.1k

US$9.9k

US$9.6k

US$9.3k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$98b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (2.5%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 6.7%.

Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = US$18b× (1 + 2.5%) ÷ (6.7%– 2.5%) = US$437b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$437b÷ ( 1 + 6.7%)10= US$229b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$327b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of US$537, the company appears a touch undervalued at a 27% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

dcf
dcf

The Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the assumptions. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that we are looking at Adobe as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighted average cost of capital, WACC) which accounts for debt. In this calculation we've used 6.7%, which is based on a levered beta of 1.011. Beta is a measure of a stock's volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

SWOT Analysis for Adobe

Strength

  • Debt is not viewed as a risk.

Weakness

  • Earnings growth over the past year underperformed the Software industry.

Opportunity

  • Annual earnings are forecast to grow faster than the American market.

  • Good value based on P/E ratio and estimated fair value.

Threat

  • Revenue is forecast to grow slower than 20% per year.

Next Steps:

Valuation is only one side of the coin in terms of building your investment thesis, and it ideally won't be the sole piece of analysis you scrutinize for a company. It's not possible to obtain a foolproof valuation with a DCF model. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. What is the reason for the share price sitting below the intrinsic value? For Adobe, there are three additional aspects you should look at:

  1. Risks: Take risks, for example - Adobe has 1 warning sign we think you should be aware of.

  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for ADBE's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.

  3. Other Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!

PS. Simply Wall St updates its DCF calculation for every American stock every day, so if you want to find the intrinsic value of any other stock just search here.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.