July 19, 2016

Adobe: Overvalued Despite Improving Profitability


Summary

  • Using Adjusted Earnings and Assets, ADBE’s Adjusted Return on Assets was 17.1% in 2015 – greater than thrice the as-reported 5% ROA most financial databases report.
  • This difference is primarily caused by ADBE’s $338mn stock option expense, which significantly distorts the firm’s economic reality.
  • Another factor that significantly distorts the firm’s economic reality is their $5.4bn goodwill, which inflates their asset base.
  • Despite the huge difference in adjusted and as-reported ROA levels, the firm’s stock may already be overvalued by the market.

ADBE - PVP Chart - 2016 07 18

Performance and Valuation Prime™ Chart

Under GAAP, the as-reported financial statements and financial ratios of ADBE do not reflect economic reality. The traditional ROA computation understates the company’s profitability by incorrectly including certain items. The distortion of both profitability measures and valuation metrics of ADBE are primarily driven by the inclusion of the firm’s goodwill ($5.4bn), which inflates the firm’s asset base, and by incorrectly expensing their non-cash stock options ($338mn).

After adjusting for similar issues and a host of other GAAP-based miscategorizations, Valens calculates ADBE’s Adjusted Return on Assets as 17% in 2015. In contrast, most financial databases show an as-reported ROA of only 5%. However, our analysis shows that ADBE has an Adjusted Forward P/E of 28.1x and an Adjusted Price-to-Book ratio of 7.1x, both of which are trading at the high end of historical valuations. Despite the distortions caused by GAAP on the firm’s profitability, the market’s view of ADBE may already be too bullish.


Click here to read the article in its entirety at Seeking Alpha.