Avoid IRMAA With Tax-Free

Nate Crosby |
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Avoiding Aunt IRMAA

In the planning world there is a relatively new phrase, “Avoid Aunt IRMAA.” IRMAA stands for Income Related Monthly Adjustment Amount. It is an additional tax that Medicare participants whose income is above a certain pay level in addition to their standard Medicare part B or D premium. The added tax is taken directly from your Social Security benefit. As a taxpayer, this is a double whammy. You were taxed to create the Social Security benefit and then IRMAA takes some of the benefit away from you. 

Much attention has been paid to inflation over the past several years, as the cost of living has increased significantly. However, chances are you may not have even heard of IRMAA. The average IRMAA tax increase since 2000 has been over 5% annually, outpacing inflation significantly.

How can you avoid having Social Security benefits reduced by IIRMA? 

The short answer is less taxable income in retirement. Roth IRA distributions, cash value life insurance distributions, municipal bond interest and health savings accounts can be powerful tools in retirement to protect your Social Security benefit. As we have discussed in prior newsletters and podcasts, anyone can grow wealth in a Roth IRA. Assets can be added to Roth IRAs either through direct contributions, indirectly through back-door Roth contributions, or Roth conversions. Indexed universal life policies (IULs), when positioned properly, have the potential to produce substantial tax-free withdrawals in retirement, and they come with a tax-free death benefit. Health Savings Accounts (HSAs) can be used tax-free in retirement years to pay for qualified medical expenses. Positioning assets now to provide tax-free income in retirement can go a long way to reduce taxation and protect benefits in the future.

New Book Release for 2025

Crosby Advisory Group, LLC is publishing a new book in the first quarter of 2025 titled, "Dynamic Growth: Accumulation & Protection." You can reserve a free copy by messaging us here. Whether you are just starting out investing or are a seasoned business owner, we believe this book has something for everyone. The book covers plan structure, savings rate, insurance protection, tax reduction, retirement income, and business growth.

CAG Analysis on the Adobe Stock

Analysis provided by Derek Ballinger, CAG Advisor

Intro

Adobe Inc. is the software company that produces digital media software like Photoshop, Adobe Premiere, After Effects, & Adobe Acrobat PDF Reader. They have a large catalog of offerings - too many to mention here - but those are the most recognizable products. Adobe is in our Quality Model and we are optimistic about the future performance in Adobe, if we are correct about the following factors: 

  1. Adobe will continue to be a leader in the Digital Media space 
  2. Generative AI will take much longer to create comparable entertainment relative to human-generated entertainment 
  3. Adobe can integrate AI tools to better their existing product line 
  4. Adobe can maintain strong fundamentals and continue to return value to shareholders through growing free cash flow 
  5. Consensus estimates are close in their forecast for the next 3 years 

If analyst expectations are met, and Adobe can generate $25.95 in earnings per share (EPS) in 2027, investors could expect to see greater than market returns by owning Adobe’s stock.

Breakdown of The Business

Adobe has been a strong business and a leader in the digital media space throughout the company’s history. They have three business segments: Digital Media, Digital Experience, Publishing & Advertising. Digital Media represents 74% of their annual revenue, this segment encompasses all of their applications, cloud services, document cloud, APIs, integrations, and generative AI assistants. Their largest segment has gross profit margins of 95.71%. Most of this is recurring revenue as well because monthly subscriptions are the driver of this segment. Annualized recurring revenue for the Digital Media segment, assuming no growth or cancellations of service for 2025, is $17.216B. For 2024 this segment has $15.864B in revenue. Digital Experience generated $5.366B in revenue with $1.589B in cost of goods sold (COGS), so gross profit margins of 70.38%. Publishing & Advertising generated $0.275B in revenue with $0.089B in COGS, so gross profit margins of 67.63%.

Fundamentals

If we look at the income statement, Adobe has been a fast-growing and profitable business. In 2024, they achieved a combined gross profit margin of 89.04% and a net profit margin of 25.85%. Selling, General, & Administrative (SG&A) Expense is their largest expense followed by Research & Development (R&D). Over the past 10 years, Adobe has grown revenue by 16.19% CAGR and has grown earnings per share by 25.89% CAGR (Compound Annual Growth Rate). They have grown free cash flow by 19.88% CAGR and reduced share count by 1.22% CAGR over the past 10 years. These growth numbers have moderated over the past 5 years, however, even though they have still grown revenue by double digits and are expected to resume double-digit profit growth in the next few years. If we look at the balance sheet, they have $7.61B in cash (as of the end of 2024) and $1.5B in debt coming due in 2025. A large part of their long-term assets is Goodwill & Intangibles, which are typically less desirable than tangible assets. They have $13.57B in Goodwill & Intangibles out of $30.23B in Total Assets. Persistently high goodwill can be an indication that Adobe overpays for acquiring other companies, it's also an indication of the power of the brand that Adobe has created. Either way, this would only be valuable to Adobe if they were acquired themselves. They can't monetize the goodwill on the balance sheet in the same way they could with fixed assets. With goodwill being 45% of their total assets, that's way higher than a company like Google (7% of total assets), but comparable to a company like Oracle (46% of total assets). Looking at cash flow, they generated $8.056B in cash flow from operations, which is way above what is needed to reinvest in the business/service debt and continue to buy back shares. They generated $7.87B in free cash flow in the past 12-months.

Valuation & Return Profile

Bear Case: Adobe is currently trading at 35.78x earnings, this is below the 5-year average of 46.66x earnings. This year, Adobe returned -23.29% as investors are concerned that generative AI tools will render Adobe’s business model obsolete. As a generative AI user, but not a generative AI expert, my opinions are not expert opinions. I am of the belief that there is a wide gap between where generative AI tools are now and where they would need to be to render human-generated entertainment obsolete. Given the rapid progress of other technologies, I might be understating the potential for exponential progress on the generative AI front. If that is the case, then why pay Adobe for video editing software, when you can just generate a movie by typing the plot into a large-language-model like ChatGPT. The same would be true for photo editing software like Photoshop, which has already integrated AI tools to enhance photo editing. This is a material threat to their existing business model and is being priced into the stock and performance in 2024.

Base Case: Adobe continues to integrate these AI tools to enhance their product line, human-generated content is enhanced with these tools, but 100% AI-generated entertainment is still a long way away or humans favor human-generated content despite how good AI entertainment gets. Other segments continue growth in line with consensus expectations. Investors could expect a return to average valuations and double-digit increases in earnings per share, driving the stock price higher.

Best Case: Adobe is a leader in the generative AI space, developing tools to merge AI tools with human-generated content. Adobe Improves efficiency and costs for content creators, and they maintain their dominance in the space and resume impressive growth trends with high margins. You could see valuation expansion beyond the average PE and impressive growth in earnings per share.

Price Targets

Bear Case: Price target is tough to quantify. The worst-case scenario is their product line becomes obsolete, and they would have to pivot and service other demands. You could imagine the stock much lower from where it is right now.

Base Case-> Bull Case: Assuming consensus expectations for the business are correct, the forecasted $25.96 earnings per share estimate in 2027 represents 25.35% growth. If Adobe maintains the current P/E ratio, that would put the 2027 price target for Adobe at $928.84. That represents an average return of 25.35% over the next three years. If the P/E ratio expands to the 5-year average P/E of 46.66, that represents a 2027 price target of $1211.23 or a compounded average return of 34.47% over the next 3 years. What The Market Is Pricing In Given 1-year expectations for both the growth of Adobe & growth in the overall stock market, the price of Adobe’s stock is indicating a 28% premium on Adobe for their 1-year growth outlook. The consensus growth expectation for the S&P 500 next year is +19.23% according to data provided by S&P Global. Adobe has provided guidance for 2025, they expect to generate $16.10 in earnings per share which is +29.83% growth. Given the market has a P/E ratio of 27.87, you could extrapolate that Adobe should have a P/E multiple of 43.23 (a 55% premium). This puts the 2025 price target for Adobe at $696.04 which is 56.9% higher than where it is right now. There are a lot of assumptions in that math, but from that perspective, it appears Adobe is trading at a discount considering management underestimates EPS and Adobe is trading at 35x earnings. Consensus estimates may be overly optimistic on EPS growth for the S&P 500 next year which would also change the output.

Adobe is one of the holdings in the CAG Quality Model. This doesn't mean we are recommending you purchase Adobe individually. If you are a do-it-yourself investor, do your own research. Not all investments are appropriate for all people. You can find more information about Adobe's financials here.

 

 

 

Crosby Advisory Group, LLC is a registered investment advisor providing financial planning, insurance and business growth strategies. This newsletter is for information purposes and does not represent individual investment advice. Not all investments are suitable for all people. You should carefully consider all risks and fees before making an investment.