3 Reasons It's Not Too Late to Board the Adobe Systems Incorporated Train

By Markets Fool.com

Adobe Systems' (NASDAQ: ADBE) stock has inched up about 4% since announcing Q2 earning on June 21, but it continues to elicit what amount to yawns from industry pundits. It was already trading above consensus analyst estimates going into the earnings report. After the report, analysts grudgingly upped expectations for the next year to $110 a share, but even that doesn't take into account Adobe's multiple upsides.

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Considering a tactical business transition that has been, and continues to be, an unmitigated success, growth opportunities in new, cutting-edge technologies, and an undervalued stock price, Adobe still belongs on a growth investor's watch list.

Image source: Adobe.

Who needs you?

Adobe naysayers will point to its existing valuation based on trailing earnings as a reason for its relatively meager upside: at least "meager," based on the 10% appreciation that consensus price targets expect from its current $100-a-share level. But the picture changes fairly dramatically for investors with an eye toward the future, rather than looking in the rearview mirror.

If Adobe hits the top end of its revenue estimate for the current quarter -- $1.47 billion -- it will have grown sales by 20% year-over-year, just as it did with Q2's record-setting $1.4 billion in sales. That same impressive growth rate is expected to continue throughout fiscal 2016. That's great to see with an established player.

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Yes, Adobe is currently trading at nearly 57 times trailing earnings, but at just 26 times future earnings due to its ongoing top-line growth, its stock takes on a whole different look. It's no wonder Adobe's forward price-earnings (P/E) ratio is a relative bargain given its revenue growth forecast across virtually every one of its business lines.

The sky's the limit

Investors have likely heard the sky-high expectations for the combined virtual reality (VR) and augmented reality (AR) markets. By 2020, according to one estimate, the combined technologies will generate a whopping $150 billion in revenue.

What makes those kind of estimates exciting for Adobe, and its engineering software counterpart Autodesk (NASDAQ: ADSK), is that both are ideally positioned to expand their respective 3D software solutions to include VR and AR. Better still, of the estimated $150 billion sales in four years, $120 billion is estimated to come from AR -- in which users are immersed in their alternative universe, but remain aware of the physical world around them -- due to its commercial applications, including Adobe's design solutions. Imagine an Adobe designer or Autodesk engineer being able to walk through a virtual design or building spec to get a sense of the space and flow before beginning the manufacturing process.

Adobe is already VR- and AR-ready in both its marketing and creative clouds. Autodesk has done Adobe one better by inking an AR-specific partnership with leader Microsoft and its HoloLens AR solution. But don't be surprised to see Adobe and Microsoft expand their existing professional relationship to include HoloLens before long. It just makes too much sense not to.

Worth a look

For the past several years, Adobe has been working on implementing CEO Shantanu Narayen's strategic initiative of driving growth in annualized recurring revenue (ARR) results -- which provide ongoing fees without relying on new sales -- across its multiple businesses. Given Adobe's forecast of a more than 20% jump in ARR through the 2018 fiscal year, investors should see more of the same going forward.

Already Adobe has an annual run rate of $3.41 billion from its creative and document cloud units, and at 20% plus growth per year on the horizon, ARR already amounts to an impressive foundation. Ongoing subscription sales also contributed to Adobe's outstanding66% jump in earnings per share (EPS) last quarter to $0.48, climbing 40% to $1.08 billion, 77% of total revenue.

It simply costs less, relatively speaking, to provide services and collect subscription fees from existing customers than relying solely on new sales. Continued ARR growth, relative value based on future earnings expectations, and the potential that AR and VR offer are all compelling reasons Adobe warrants a good, hard look from long-term growth investors.

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Tim Brugger has no position in any stocks mentioned. The Motley Fool owns shares of Microsoft. The Motley Fool recommends Adobe Systems. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.