Adobe Actually Cheaper on Valuation After It Rises

As impressive as Monday's earnings and stock rally for Adobe (ADBE - commentary - Cramer's Take) was, perhaps even more impressive is the fact that the stock appears cheaper after going up than before.

According to Yahoo!, the consensus estimate for FY2007 (Nov) is $1.51, meaning at Monday's close, it was trading at 28.5 times 2007 earnings estimates. After the nickel beat and three-cent guidance increase, based on after-hours trading at $44.76, it is only at 28.1 times.

That said, 2007 is so last year -- most investors are already looking ahead to 2008 and beyond. With no major product upgrades expected until late 2008 at the earliest, there is more than a small possibility that this year's upside comes out of sales that would otherwise have been made next year.

Growth was already expected to slow from 17.5% this year to 12.5% in 2008. If the estimates for next year aren't raised, growth from the new guidance will be in the single digits.

I'm quite confident the estimates for 2008 will be raised. But that's not to say that everything about the earnings report was fine and dandy. License sales are growing more slowly than total revenue, with the remainder being service and support. Because licenses have to be sold before support can be provided, the slower license sales point to a slowdown in support growth later on.

Plus, deferred revenue is growing at a slower rate (if only slightly) than booked revenue. This indicates that the license revenue will probably continue to slow as well. Furthermore, the growth is in current deferred revenue -- long-term deferrals are down 18% since December 2006.

Cash Is King

But enough with the forensic accounting. Cash is king, and Adobe's free cash flow over the last four quarters is about $1.25 billion, giving the company a free-cash-flow yield north of 5%. Even if the $100 million provided by a reduction in accounts receivable is excluded (as being nonrecurring), the yield is still nearly 5%.

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At the time of publication, Trent was short ADBE naked put options until Friday expiry, although positions may change at any time.

William A. Trent, CFA, is a freelance equity analyst based in the New York metro area. He has been an equity analyst since 1996 and is co-author of Understanding and Evaluating Prospectuses, Offering Documents, and Proxy Statements. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Trent appreciates your feedback; click here to send him an email.