Shares of Adobe Systems have soared over the past few years on hope that the company's transition to a subscription-only business model for its software would pay dividends in the future. With that transition largely behind it, Adobe trades at an extremely optimistic valuation, leaving little room for error.
That is not to say that Adobe's stock price can't go higher. In fact, there are a few reasons to believe it could do just that. We don't know what the stock will do, but let's take a look at three developments that could send it higher.
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Accelerating Creative Cloud subscription growthAdobe's shift to a subscription-only model certainly did not come without risk. The big question was whether existing customers would be willing to switch from paying for a perpetual software license to paying a monthly fee. Both revenue and profit took a major hit during the past two years as Adobe executed this transition, but the move appears to bepaying off.
Creative Cloud subscriber growth accelerated throughout 2014, with each quarter adding more subscribers than the last.
Adobe expects its digital media segment, which contains Creative Cloud, to grow revenue at a 20% rate over the next few years. By the end of the next fiscal year, the company expects to have raised its subscriber count to 5.9 million, which would require an average of 612,000 new subscribers each quarter. Given the acceleration during 2014, this target could prove conservative, and if Adobe continues to report solid subscriber growth beyond its own estimates, the stock could continue to rise.
Leading the digital marketing chargeDigital marketing is Adobe's second core business. Adobe's Marketing Cloud is its subscription-based offering, and it generated $1.17 billion in revenue during 2014, growing by about 15% annually. Adobe expects Marketing Cloud revenue growth to accelerate, with a target of 25% annual growth over the next few years.
Adobe has become one of the leaders in digital marketing, and the market is expected to get much bigger in the coming years. IDC predicts the global marketing software market will expand by 50% through 2018, rising to $32.8 billion. If Adobe can maintain a leading position in the industry, its 25% growth target doesn't look at all far-fetched.
The digital marketing industry is evolving, and there's no guarantee Adobe can turn its early success into the kind of dominance it has in creative software. The company has made acquisitions to grow its digital marketing business, and more purchases are likely as the company attempts to stay ahead of competitors includingsalesforce.com, IBM, and Oracle. If Adobe can hit its aggressive growth targets over the next few years, or even surpass them, the stock could very well soar.
Rapid earnings growthAdobe has set lofty earnings expectations for the next few years. The company's earnings have been depressed over the past two years due to the transition to subscriptions, but with the shift now largely over, earnings are expected to explode. In fiscal 2014, Adobe reported $1.29 per share in non-generally accepted accounting principles, or non-GAAP, earnings. This is expected to grow to roughly $2 per share in fiscal 2015 and to about $3 in fiscal 2016, representing 130% growth in just two years.
GAAP numbers will be far lower, given that Adobe adds back stock-based compensation to arrive at its non-GAAP figures, but the market is clearly betting on fantastic earnings growth in coming years. This will require Adobe to hit its revenue growth targets for both Creative Cloud and Marketing Cloud, as well as to greatly improve profitability compared to the past couple of years.
The market loves nothing more than rapid, consistent earnings growth, and that is exactly what Adobe is promising. If the company can grow earnings as rapidly as it projects, the stock could rise significantly over the next few years. On the flip side, if the company falls short, it won't be fun being an Adobe shareholder given the stock's lofty valuation.
The article 3 Reasons Adobe Systems' Stock Could Rise originally appeared on Fool.com.
Timothy Green owns shares of International Business Machines. The Motley Fool recommends Adobe Systems and Salesforce.com. The Motley Fool owns shares of International Business Machines and Oracle. 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.
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