Mad Hedge Technology Letter
December 6, 2018
Fiat Lux
Featured Trade:
(A BIG ESCALATION OF THE TRADE WAR)
(INTU), (MSFT), (HUAWEI), (SQ), (ABDE)
Posts
CFO of Huawei Meng Wanzhou was arrested transiting in Vancouver and is facing extradition to the United States to face the accusation that she violated sanctions against Iran.
This doesn’t help calm the nerves of tech investors. Not at all.
Wanzhou is the daughter of Founder and President of Huawei Ren Zhengfei who springboarded to success after his close ties to the People’s Liberation Army helped propel his career in technology when Shenzhen opened up its economy in the 1980s.
He has never looked back since then developing Huawei into one of the key cogs of the global telecommunications infrastructure.
Huawei’s rapid ascent has been the defacto Achilles heel between the United States and Chinese tech relations gone sour.
China is hell-bent on dominating 5G and beyond, and the Chinese communist views Huawei as a critical component to executing this vision.
That being said, there are plenty of tech stories out there that are worth a look irrespective of the macro headaches.
In a time like this, avoiding China-themed tech stocks would offset some volatility as shares have been on a rollercoaster because of issues unrelated to the companies themselves.
Software companies with income streams closely linked to domestic revenue is a trope that I have recommended and will outperform the pure tech growth stocks in 2019.
A company that epitomizes these traits is Intuit (INTU). The problem with it is that it is too expensive right now as well as having growth-related road bumps.
Intuit is a company your family tax accountant loves and hates.
It is a financial software taking care of financial, accounting, and tax preparation for small businesses, accountants, and individuals.
The company is headquartered in Mountain View, California.
The bulk of its revenues derive from operations within the United States and that is music to my ears right now in this climate.
Intuit also owns TurboTax which is one of the most popular domestic income tax preparation software packages in the United States.
Quickbooks Online, another type of accounting software owned by Intuit, is the firm’s bread and butter product and expanded over 40% YOY.
Even with this premium growth, the small business unit was only able to grow 11% YOY.
Quickbooks Online now has 3.6 million subscribers demonstrating the large scope of its business.
Through feast or famine, people will always need accounting and financial software even with a fractious global trade war threatening to topple global trade.
This software stock will provide stable earnings and reliable profits because of its defensive nature.
However, its 3-year revenue growth of 12% is not what premium tech companies produce. Intuit needs to ramp up its revenue drive and I believe the changing of CEO from old hand Brad Smith to his hand-picked successor Sasan Goodarzi will do the trick.
Goodarzi has indicated that he intends to migrate up the value chain into the mid-tier business revenue stream hoping to land some notable deals.
His immediate job is to identify a solution to help accelerate the firm’s top-line growth again.
The addressable market is massive, and Intuit isn’t capitalizing on its position with smaller companies, leaving the opportunity to upsell more advanced software to customers on the table.
The alarm bells should be ringing.
Intuit requires an upgrade in its software strategy in an evolve-or-die tech climate.
Nurturing small business customers is part and parcel to adopting a legitimate growth strategy as the status quo moving forward.
Weeding out one’s core customer base is a kamikaze mission.
If Intuit nails this transition, then new income streams will open up while retaining old customers.
That being said, Intuit is still a good company and could become a great company if they want to.
They even have a dividend yield of 0.8%.
Intuit is an incredibly profitable company and has increased their 3-year EPS growth rate to 27%, presiding over high-profit margins of 33%.
Financial products which include financial software are incredibly sticky and I would lump accounting software into that group too.
Accountants do not fancy switching over accounting software every year and risk fudging the numbers.
The company has made around $1 billion in profits the past three years and annual revenue has steadily climbed from $4.19 billion in 2015 to $5.96 billion in 2018.
Management indicated that 2019 revenue will come in around $6.5 to $6.6 billion, a jump of around 8-10%.
In my books, 8-10% of a company of this ilk isn’t good enough.
I am hoping new management will roll out the Microsoft (MSFT) playbook which focused on its subscription as a service (SaaS) revenue stream and reaped the untold rewards.
Intuit needs to wean itself from selling packaged products.
And the 11% growth in last season's earnings report was a pitiful deceleration from 17% the year before.
It is clear that management has not pumped enough juice out of this baby and fresh blood should invigorate management at the top level.
Highlighting the attractive possibilities to grow the existing user base is the uptick in self-employed subscribers within QuickBooks online surging to around 745,000 from 425,000 YOY.
Cross-selling to this existing subscriber base would increase average revenue per user.
On a sour note, strength isn’t happening across the board with the desktop ecosystem revenues of $537 million sliding 4% YOY.
Intuit isn’t harnessing the tools they currently possess.
Converting the critical customer feedback into actionable results will boost the company’s products and would be a big first step in making this a premier software company along the lines of Adobe (ADBE).
They have the foundation set up to achieve an Adobe-like revenue trajectory.
A revamp to the sorely lacking functionality will drive more revenue and keep customers happy as well as pulling in more mid-tier income streams.
I wouldn’t label Intuit a strong buy at this point and short-term macro weakness is a great reason to hold off on this stock before making the plunge.
Longer term, I pray that fintech newcomer Square (SQ) won’t expand into the individual accounting software industry because the rate of innovation percolating inside of Square’s office walls is second to none.
Tax software would be on the chopping block if Square can get its act together and make a beeline towards this segment.
Technology rewards the brute force innovators and Square wants to disrupt anything that involves digital finance.
I believe Intuit has good and not great software, but the lack of innovation could decimate them down the line once a serious innovator starts to eye their addressable market.
In any case, if Intuit becomes cheaper sliding to the $150-$160 levels from the $207 today, that would serve as a smart entry point into this above average software stock.
However, there are higher quality software companies out there, especially many whose revenue isn’t decelerating and some whose annual revenue is doubling every two years like Square.
Global Market Comments
November 30, 2018
Fiat Lux
Featured Trade:
(NOVEMBER 28 BIWEEKLY STRATEGY WEBINAR Q&A),
(VXX), (VIX), (GE), (ROKU), (AAPL),
(MSFT), (SQ), (XLK), (SPLS), (EWZ), (EEM)
Below please find subscribers’ Q&A for the Mad Hedge Fund Trader November 28 Global Strategy Webinar with my guest and co-host Bill Davis of the Mad Day Trader.
Q: Is it time to get out of semiconductor stocks?
A: The time to get out is before it drops 60%, not afterwards. So, if you have semiconductor stocks, I would look for the next major rally to get out. I think we will get one of those rallies into December/January. We went negative on this sector in June, took all our profits, and didn’t go back in until last week.
Q: Is it time to buy semiconductor stocks?
A: No, that is the group you want to buy at the absolute bottom of the next recession which might be next year sometime. They lead on the downside, and they will lead on the upside as soon as they sniff a recovery in the economy.
Q: I held on to my position in Square (SQ). Should I sell now for a small profit?
A: Yes, in recessions, big companies prosper much more than small companies like Square; that’s why it had such a tremendous selloff; down 55% in six weeks. A small technology stock is not what you want to own in a recession. Big companies slow down, small ones die. At least that’s how conservative investors see it.
Q: What do you make of Fed comments this morning that asset prices are high?
A: I agree with them. They were certainly overpriced with a P/E multiple of 20 that we saw in September; they’re moderately priced now with a P/E multiple of 14.9. I think real estate markets are the overpriced assets that the Fed is talking about though, far more than the stock market, and markets like San Francisco, Seattle, and Vancouver are still way too high.
Q: What are your comments on Apple (AAPL)?
A: There’s an interesting thing going on here; you’ve just had a massive move out of hardware stocks like Apple, which basically makes phones and computers, into software stocks like Microsoft (MSFT), which is growing their cloud business like crazy. You may see this as a long-term industry trend, out of hardware stocks into software stocks. It’s all about the cloud now. The future is in software and that is where Apple is going to with services like the cloud, iTunes, streaming, and advertising, although they are doing it slowly.
Q: Will Trump be able to persuade Fed Chair Powell to stop hiking interest rates?
A: He will not, Powell is one of the few principled people in the government. He’s going to stick to his discipline, only look at the data, and that is going to require him to keep raising interest rates. One of the big black swans for 2019 may be that Trump fires Powell and gets a friendly rent-a-Fed chair in there who lowers interest rates on command. If Trump can hold on for nine months though, even Powell will see the economy’s in trouble and will have to respond accordingly by capping or even lowering interest rates.
Q: Why are you not stopping out of Roku (ROKU)?
A: We haven't yet approached our upper strike price on the December $30-$35 vertical bull call spread. That’s usually where I bail out; I like to give stocks plenty of room to do the right thing. Stocks have to breathe and I pick strike prices to compensate for that. Otherwise, you’d be stopping out of every trade immediately.
Q: Should we close the iPath S&P 500 VIX Short Term Futures ETN (VXX) trade or leave it open?
A: I’m looking for a bit more of a rally in stocks and a drop in the Volatility Index (VIX); then we’ll try to grab whatever additional couple of pennies we can get out of that.
Q: What do you think of Brazil (EWZ)?
A: Avoid emerging markets (EEM) as long as the U.S. is raising interest rates and the dollar is strong. Rising dollar means rising debt for emerging markets and less ability to service that debt, all bad for business.
Q: Morgan Stanley (MS) says “buy emerging markets”; are they nuts?
A: For the short term yes, for the multi-year long term they are a screaming buy. They are at historical lows in terms of valuation and already have a recession priced into them. But jumping in too soon could be painful.
Q: What are your expectations for the yield curve?
A: I expect all levels of the fixed income market to drop in price and rise in yield with the sharpest move in overnight rates. This eventually leads to a very steep inverted yield curve which causes recessions and bear markets.
Q: Thoughts on Master Limited Partnerships?
A: They could be relatively safe now that oil is at $50. There have been big selloffs recently. The yield on these are high and there is going to be big infrastructure building for energy going forward. I would say don’t put all your eggs in one basket and diversify your risk. In the Great Recession, many of these went bankrupt. I would look at the Alerian MLP (AMLP), which has fallen 15% in six weeks.
Q: Should I be rotating out of the Tech (XLK) stocks on rallies into more defensive stocks like Staples (SPLS)?
A: That’s half right. You should be rotating out of Tech stocks and rotating into cash which yields up to 2-3% these days. Nothing does well in a real bear market except cash. Defensive stocks still go down, just at a slower rate.
Q: Is General Electric (GE) good for the long term?
A: Yes, if anyone can turn around GE it’s the current management. That said, it could be a long-term slog—that’s why I had a long-term leap in this thing before it collapsed. It could turn around and still go up but these are throwaway, chapter eleven level type prices that we’re getting now. And now they are going to have to do a turnaround going into a recession.
Q: Do you see GE as good for a long-term trade?
A: Long term and trade don’t belong in the same sentence; but I’d say for a long-term investment at these levels, probably yes. It certainly is a bargain from $30 down to $7.40 in a year.
Q: Is this webinar archived?
A: A: Yes, they are always posted on the website within two hours of recording. Just go to www.madhedgefundtrader.com/, login and then hover your cursor over “MY ACCOUNT” click on “GLOBAL TRADING DISPATCH,” “Mad Hedge Technology Letter” or “Newsletter” depending on your membership then click on the Webinars button. The last ten years of webinars should show up, with the most recent one at the top.
Good luck and good trading.
John Thomas
CEO & Publisher
The Diary of a Mad Hedge Fund Trader
One of the fastest parts of technology growing at a rapid clip is fintech.
Fintech has taken the world by storm threatening the traditional banks.
Companies such as Square (SQ) and PayPal (PYPL) are great bets to outlast these dinosaurs who have a laser-like focus on technology to move the digital dollars in an efficient and low-cost way.
Another section of the technology movement that has caught my eye morphing by the day is the online food delivery segment that has soaring operating margins aiding Uber on their quest to go public next year.
There have been whispers that Uber could garner a $120 billion valuation dwarfing Chinese tech giant Alibaba’s (BABA) IPO which was the biggest IPO to date at $25 billion.
Uber is following in Amazon’s footsteps executing the “blitzscaling” method to suppress competition.
This strategy involves scaling up as quick as possible and seizing market share before anyone can figure out what happened.
The growth explodes at such speed that investors pile in droves throwing inefficient capital at the business leading the company to make bold bets even though profit is nowhere to be seen.
Blitzscaling has fueled American and Chinese tech to the top of the global tech charts and the trade war is mainly about these two titans jousting for first and second place in a real-time blitzscale battle of epic proportion.
The audacious stabs at new businesses usually end up fizzling out, but the ones that do have the potential to blaze a trail to profitability.
One business that has Uber giving hope of one day returning capital to shareholders is Uber Eats – the online food delivery service.
Total sales of restaurant deliveries will hit 11% of revenue if the current trend continues in 2022 marking a giant shift in consumer attitudes.
No longer are people eating out at restaurants, according to data, younger generations view ordering from an online food delivery platform as a direct substitute.
This mindset is eerily similar to Millennials attitude towards entertainment.
For many, Netflix (NFLX) is considered a better option than attending a movie theatre, and all forms of outdoor entertainment are under direct attack from these online substitutes.
One firm on the forefront of this movement has been Domino’s Pizza (DPZ).
You’d be surprised to find out that over half of the Domino’s Pizza staff are software developers.
They have focused on the customer experience doubling down on their online platform to offer the easiest way to order a pizza.
In 2012, the company was frightened to death that it still took a 25-step process to order a pizza.
By 2016, Domino’s rolled out “zero-click ordering” offering 15 different ways to order their product across many major platforms including Amazon’s Alexa.
This has all led to 60% of sales coming from online and rising.
The consistency, efficiency, and seamless online payment process has all helped Dominoes stock rise over 800% since May 2012 and that is even with this recent brutal sell-off.
Uber is perfectly positioned to take advantage of this new generation of dining in.
In the third quarter, Uber booked $2.1 billion of gross booking volume in their powerful online food delivery service.
The 150% YOY rise makes Uber Eats a force to be reckoned with.
Uber’s investment into e-scooters and bike transportation stems from the potential synergies of online food delivery efficiency.
It’s cheaper to deliver pizzas on a bicycle or anything without an internal combustion engine.
If you ever go to China, the electric powered three-wheel modified tuk-tuk with a storage compartment in the back instead of passenger seating is pervasive.
Often navigating around narrow alleyways is inefficient for a four-wheel automobile, and as Uber sets its sights on being the go-to last mile deliverer of food and whatnot, building out this vibrant transport network is vital to its long-term vision.
In fact, Uber is not an online ride-sharing platform, it will be something grander and its Uber elevate division could showcase Uber’s adaptability by making air transport cheap for the masses.
As soon as the robo-taxi industry gathers steam, Uber will ditch human drivers for self-driving technology saving billions in labor costs.
As it stands, Uber keeps cutting the incentive to drive for them with rates falling to as low as an average of $10 per hour now.
The golden age of being an Uber driver is long gone.
Uber is merely gathering enough data to prepare for the mass roll-out of automated cars that will shuttle passengers from point A to B.
It doesn’t matter that Lyft has gained market share from Uber. Lyft’s market share was in the teens a few years ago and has rocketed to 31% taking advantage of management problems over at Uber to wriggle its way to relevancy.
It does not reveal how poor of a company Uber is, but it demonstrates that Uber’s network is spread over different industries and the sum of the parts is a lot greater than Lyft can fathom.
Lyft is a pure ride-share company and brings in annual revenue that is 4 times less than Uber.
Naturally, Uber loses a lot more money than Lyft because they have so many irons in the fire.
But even a single iron could be a unicorn in its own right.
CEO Dara Khosrowshahi recently talked about its Uber Eats division in glowing terms and emphasized that over 70% of the American population will have access to Uber Eats by the end of next year.
Uber’s position in the American economy as a pure next-generation tech business reverberates with its investors causing Khosrowshahi to brazenly admit that Uber “suffers from having too much opportunity as a company.”
Ultimately, the amped-up growth of the food delivery unit feeds back into its ride-sharing division. These types of synergies from Uber’s massive network effect is what management desires and dovetails nicely together.
In 2018 alone, 40% of Uber Eat’s customers were first-time samplers.
A good portion of these customers have never tried Uber’s ride-sharing service and when they travel for business or leisure, they later adopt the ride-sharing platform leading to more Uber converts.
Uber Freight has enabled truckers to push a button and book a load at an upfront price revolutionizing the process.
The online food delivery service is the place to be right now and it would be worth your while to look at GrubHub (GRUB).
Quarterly sales are growing over 50% and quarterly EPS growth was 61% sequentially for this industry leader.
Profit Margins are in the mid-20% convincingly proving that the food delivery industry will not be relying on razor-thin margins.
Charging diners $5 for delivery and taking a cut from the restaurateurs have been a winning strategy that will resonate further as more diners choose to munch in the cozy confines of their house.
Blitzscaling has led Uber to the online food delivery business and they are pouring resources into it to juice up profits before they go public next year.
The ride-sharing business is a loss-making enterprise as of now, and Uber will need to exhibit additional ingenuity to leverage the existing network to find strong pockets of revenue.
I believe they have the talent on their books to achieve finding these strong pockets making this company an intriguing stock to buy in 2019.
Global Market Comments
November 19, 2018
Fiat Lux
Featured Trade:
(THE MARKET OUTLOOK FOR THE WEEK AHEAD, or MASS EVACUATION)
(SPY), (WMT), (NVDA), (EEM), (FCX), (AMZN), (AAPL), (FCX), (USO), (TLT), (TSLA), (CRM), (SQ)
I will be evacuating the City of San Francisco upon the completion of this newsletter.
The smoke from the wildfires has rendered the air here so thick that it has become unbreathable. It reminds me of the smog in Los Angeles I endured during the 1960s before all the environmental regulation kicked in. All Bay Area schools are now closed and anyone who gets out of town will do so.
There has been a mass evacuation going on of a different sort and that has been investors fleeing the stock market. Twice last week we saw major swoons, one for 900 points and another for 600. Look at your daily bar chart for the year and the bars are tiny until October when they suddenly become huge. It’s really quite impressive.
Concerns for stocks are mounting everywhere. Big chunks of the economy are already in recession, including autos, real estate, semiconductors, agricultural, and banking. The FANGs provided the sole support in the market….until they didn’t. Most are down 30% from their tops, or more.
In fact, the charts show that we may have forged an inverse head and shoulders for the (SPY) last week, presaging greater gains in the weeks ahead.
The timeframe for the post-midterm election yearend rally is getting shorter by the day. What’s the worst case scenario? That we get a sideways range trade instead which, by the way, we are perfectly positioned to capture with our model trading portfolio.
There are a lot of hopes hanging on the November 29 G-20 Summit which could hatch a surprise China trade deal when the leaders of the two great countries meet. Daily leaks are hitting the markets that something might be in the works. In the old days, I used to attend every one of these until they got boring.
You’ll know when a deal is about to get done with China when hardline trade advisor Peter Navarro suddenly and out of the blue gets fired. That would be worth 1,000 Dow points alone.
It was a week when the good were punished and the bad were taken out and shot. Wal-Mart (WMT) saw a 4% hickey after a fabulous earnings report. NVIDIA (NVDA) was drawn and quartered with a 20% plunge after they disappointed only slightly because their crypto mining business fell off, thanks to the Bitcoin crash.
Apple (AAPL) fell $39 from its October highs, on a report that demand for facial recognition chips is fading, evaporating $170 billion in market capitalization. Some technology stocks have fallen so much they already have the next recession baked in the price. That makes them a steal at present levels for long term players.
The US dollar surged to an 18-month high. Look for more gains with interest rates hikes continuing unabated. Avoid emerging markets (EEM) and commodities (FCX) like the plague.
After a two-year search, Amazon (AMZN) picked New York and Virginia for HQ 2 and 3 in a prelude to the breakup of the once trillion-dollar company. The stock held up well in the wake of another administration antitrust attack.
Oil crashed too, hitting a lowly $55 a barrel, on oversupply concerns. What else would you expect with China slowing down, the world’s largest marginal new buyer of Texas tea? Are all these crashes telling us we are already in a recession or is it just the Fed’s shrinkage of the money supply?
The British government seemed on the verge of collapse over a Brexit battle taking the stuffing out of the pound. A new election could be imminent. I never thought Brexit would happen. It would mean Britain committing economic suicide.
US Retails Sales soared in October, up a red hot 0.8% versus 0.5% expected, proving that the main economy remains strong. Don’t tell the stock market or oil which think we are already in recession.
My year-to-date performance rocketed to a new all-time high of +33.71%, and my trailing one-year return stands at 35.89%. November so far stands at +4.08%. And this is against a Dow Average that is up a miniscule 2.41% so far in 2018.
My nine-year return ballooned to 310.18%. The average annualized return stands at 34.46%. 2018 is turning into a perfect trading year for me, as I’m sure it is for you.
I used every stock market meltdown to add aggressively to my December long positions, betting that share prices go up, sideways, or down small by then.
The new names I picked up this week include Amazon (AMZN), Apple (AAPL), Salesforce (CRM), NVIDIA (NVDA), Square (SQ), and a short position in Tesla (TSLA). I also doubled up my short position in the United States US Treasury Bond Fund (TLT).
I caught the absolute bottom after the October meltdown. Will lightning strike twice in the same place? One can only hope. One hedge fund friend said I was up so much this year it would be stupid NOT to bet big now.
The Mad Hedge Technology Letter is really shooting the lights out the month, up 8.63%. It picked up Salesforce (CRM), NVIDIA (NVDA), Square (SQ), and Apple (AAPL) last week, all right at market bottoms.
The coming week will be all about October housing data which everyone is expecting to be weak.
Monday, November 19 at 10:00 EST, the Home Builders Index will be out. Will the rot continue? I’ll be condo shopping in Reno this weekend to see how much of the next recession is already priced in.
On Tuesday, November 20 at 8:30 AM, October Housing Starts and Building Permits are released.
On Wednesday, November 21 at 10:00 AM, October Existing Home Sales are published.
At 10:30 AM, the Energy Information Administration announces oil inventory figures with its Petroleum Status Report.
Thursday, November 22, all market will be closed for Thanksgiving Day.
On Friday, November 23, the stock market will be open only for a half day, closing at 1:00 PM EST. Second string trading will be desultory, and low volume.
The Baker-Hughes Rig Count follows at 1:00 PM.
As for me, I'd be roaming the High Sierras along the Eastern shore of Lake Tahoe looking for a couple of good Christmas trees to chop down. I have two US Forest Service permits in hand at $10 each, so everything will be legit.
Good luck and good trading.
John Thomas
CEO & Publisher
The Diary of a Mad Hedge Fund Trader
Mad Hedge Technology Letter
November 7, 2018
Fiat Lux
Featured Trade:
(THE RELIABILITY OF ADOBE)
(ADBE), (GOOGL), (ZEN), (TWLO), (SQ)
Tech companies have a habit of suddenly coming and going because of the nature of the relentless environment that spits out losers and celebrates winners.
It’s hard-pressed to find software companies that pass the test of time but there is one that is healthily chugging along that most people know quite well.
Adobe (ADBE) was established 35 years ago in co-founder John Warnock's garage.
This legacy software company’s name, Adobe, was named after the Adobe Creek in Los Altos, California, which ran behind Warnock's house.
Adobe cut its teeth in an era when tech CEOs were not larger-than-life cult figures, and all Adobe has done is quietly infiltrating its way into everybody’s devices by way of Adobe Flash Player and its smorgasbord of useful software applications.
Adobe acquired Macromedia in 2005 which was responsible for building Adobe Flash Player.
This Macromedia software has been developed and distributed by Adobe Systems ever since the purchase and its functions involve viewing multimedia contents, executing rich internet applications, and streaming audio and video. Flash Player can run from a web browser as a browser plug-in or on supported mobile devices.
Flash player was its second hit success software program after its Adobe Acrobat and Reader software introduced PDF, the Portable Document Format, which is still ubiquitously used today even after all these years.
Most software companies are relatively new to the scene and like companies I have recently written about such as Zendesk (ZEN) and Twilio (TWLO), they can brag about growing sales of 30% or 40% plus per year.
Adobe isn’t too shabby itself growing sales at over 24% annually – remarkably high for such an ancient tech company.
The company’s strengths are similar to that of Apple (AAPL) – high-quality products and high profitability.
There will be no back-to-back doubling of the stock like some hyper-growth tech stocks because Adobe doesn’t subscribe to the type of growth trail that Square (SQ) has blazed.
What you can expect from Adobe is a slow grind up in share price stoked by its outperforming EPS expansion and acceptable sales growth of mid-20%.
Its annual operating margins have essentially tripled since the beginning of 2015 from around 10% and now boasts an Apple-like 30%.
There are no bones about it – Adobe has high-quality software across its diversified portfolio.
Other Adobe software products universally soaked up are its stable array of graphic design software such as Adobe Photoshop and Adobe Dreamweaver.
Adobe has also ventured into video editing, animation, and visual effects with Adobe Premiere Pro.
Not only that, Adobe has forayed into more conventional types of software such as digital marketing management software and server software.
Simply put, Adobe’s assortment of digital media software products has a religious-like following especially for iOS users.
As you might have guessed correctly, the lion’s share of Adobe’s revenue stream stems from its software as a service (SaaS) segment contributing 80% to the top line.
More narrowly, the digital media segment makes up almost 70% of the subscription-based revenue. This division will expand at least 20% each year boding well for Adobe to maintain its 20% plus sales growth that any legacy software company would sacrifice a right leg to achieve.
It’s digital marketing software products rub up against stifling competition in Alphabet (GOOGL) amongst others and contribute a less robust 30% to overall sales.
I am less bullish on this part of the business because they have it rough competing against one of the Fangs, the path of less resistance clearly sides with its bread and butter of the digital media offerings.
Its subscription-based pricing model was the catalyst for boosting profitability causing the stock to experience massive price gains. The stock has doubled in the past two years which is unheard of for most legacy software companies.
No longer does Adobe need to manufacture the ancient CD of yore physically delivering it to customers, users can briskly download these products directly from the official website, receive constant upgrades over broadband internet, and pay Adobe monthly for their humble services.
In fact, any investors looking for some hot software stocks only need to find companies that recently shifted to a subscription-based pricing model. It’s pretty much a license to print money if the software quality can backup the monthly costs for the user.
I can tell you that Adobe’s software has remained world class, embedded at the heart of most digital devices at home and in the office, and who would have thought that just a little shift to the pricing model would have doubled the stock price?
Well, instead of one-off sales, Adobe can book revenue month after month, and year after year demonstrating the supercharged effect of shifting to a recurring revenue stream model.
Highlighting the pivot to profitability is Adobe’s three-year EPS growth rate of 48% turning this company into a mammoth software company with a $117 billion market cap.
Another positive for Adobe’s future sales are its fertile addressable markets in Europe and Asia.
There is ample room to expand in these geographical regions with Europe already chipping in with almost $2 billion of revenue per year and Asia with another $1 billion.
Future harvests look even more bountiful.
These two regions make up almost 40% of sales and as the Asian middle class is poised to elevate a giant swath of its people to middle class, Adobe will be a handsome beneficiary of this trend as middle-class families tend to pump out more university graduates who migrate to software-based occupations.
Even though Adobe isn’t the sexiest name out there, it certainly is in the category of “safe.”
In no way do I see an eradication of its embedded software spread widely throughout the tech universe.
Its digital media software tools are best-in-show and loyally followed with a long-lasting revenue stream that has room to grow abroad.
Do not expect Adobe to debut any earth-shattering products, but I fully anticipate Adobe to become even more profitable to the point that they might offer a dividend or reallocate capital to shareholders through stock buybacks.
Apple has similar strengths in its business model, albeit on a much grander scale.
I feel that Adobe doesn’t get the credit it deserves because of its steady as it goes drivers that keep motoring higher in an industry that adores groundbreaking products that revolutionize the world.
I would wait for a major sell-off because a double in two years has bid up the stock to expensive levels represented in its premium forward PE multiple of 35.
However, as the conclusion of the mid-term elections offers some certainty to the market, tech stocks could get swept up in a positive rush to round out the year.
Luckily for Mad Hedge Tech readers, this is the golden age for software companies and we are just scratching the surface of the capability software efficiencies can deliver to small and large companies across every bit of the economy.
Another Apple-like similarity is that Adobe is annually voted one of the best places to work according to Fortune, stacked up against companies represented across the full economic spectrum and not just tech.
If you have a kid, tell him to find a job in San Jose, he or she could find worse places to cut a paycheck.
Mad Hedge Technology Letter
November 6, 2018
Fiat Lux
Featured Trade:
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