I’m a tech investor. Most of my sector has crushed it during the pandemic as the world rushes to digitize. Tech’s the beast. Game over. After the “revenge of the nerds” rotation back into cyclical and value names peters out next year, I bet that tech will continue to outperform. Fundamentals for the tech leaders that are digitizing the world are strong and are accelerating in many cases. Growth stocks must beat value names when interest rates are 0%, and economic growth is subdued.
Adobe (ADBE) is one of these tech stars. I particularly admire its early shift to the cloud under CEO Shantanu Narayen, who’s a Silicon Valley stud. No surprise, this week, the company continued its streak of solid quarterly financial results and offered impressive revenue guidance for the next fiscal year. Why did the Street pooh-pooh this performance? Why is this stock -12% since September? This is a kick-ass company and a clear COVID business shift beneficiary.
Here’s the rub, and we should be wary of it as other companies, particularly those with shares that have skyrocketed this year, announce their results over the next few quarters, and analysts compare them to the COVID-impacted, year-ago periods. Perversely, COVID has been a blessing for firms that have shifted to remote working without much drop in productivity. Furthermore, T&E (travel and expense) costs have been slashed because salespeople have been pitching on Zoom and have been off the road avoiding conference boondoggles. If those client-facing expenses return – we’ll see how COVID permanently changes business, but probably not until we’re deep into 2021 – then some of these companies will face a double whammy of higher T&E spending while their sales slow from explosive to mere mortal rates as the COVID crush, which, again, has benefited digital enablers, subsides. Unfortunately, this leads to profit margin compression. ADBE exemplifies this effect. In fiscal 2020, the company’s sales and non-GAAP earnings per share (NG EPS) were +15% and +28%, respectively. Revenues are expected to accelerate (+18%) in fiscal 2021, but NG EPS should slow to “just” +11%. Such earnings growth deceleration is a problem for richly valued stocks like ADBE.