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How Investors Need to Approach Adobe Systems Incorporated

Dana Blankenhorn

When a hot stock falls, the first instinct is always to “buy the dip.” Adobe Systems Incorporated (NASDAQ:ADBE) is no exception.

ADBE is certainly a hot stock. The move of its graphics software to the cloud opened vast new markets for the company in marketing and deep learning. It is to software in that arena what NVIDIA Corporation (NASDAQ:NVDA) is to hardware.

Who wouldn’t want a piece of that, especially it goes on sale at 6% off its late November price?

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Not Luke Lango, who expects a big rebound. Not James Brumley, who sees Adobe creating software people once thought impossible.

Still, a dip in a hot stock still leaves one with pricey merchandise. Even at its present level, Adobe is selling at 54 times earnings. Its market cap of $85 billion is about 14 times last year’s sales of $5.8 billion. Operating cash flow had already doubled 2016’s total in the first three quarters, but was just $4 billion.

Why Buy Adobe Systems Inc. Stock Now?

You may not have much time to buy this dip, either. Adobe reports earnings Dec. 14, with analysts expecting $1.16 per share — and whispering about $1.19 per share — on revenues of $1.95 billion. If the company beats those estimates, the stock price may be out of reach by the end of the week.

The dip was based on a downgrade of the stock by an analyst at JPMorgan Chase & Co. (NYSE:JPM), one of many downgrades in the software sector, mainly because stocks have already hit price targets for next year.

Still, four in five analysts still have a positive rating on the stock, and none of the 38 following it have it rated as a sell.  The Morgan call hit the stock hard, but its fundamentals remain strong.

In this case, an investor with a five-year time horizon should be a buyer. Even if the stock falls from here, its prospects are such that it will almost certainly make up that ground over time.

But there is also a bearish case to be made.


The Bear Case for ADBE Stock

The bear case starts with the fact that the huge gains Adobe Systems got from its move to the cloud are past, and future gains will have to be based on organic growth.

For Adobe, that means Sensei AI, which is now going into products such as Lightroom, where it is automating edits and making some artists wonder whether they, or the software, are in charge of the final product.

Sensei is about more than images. It can create sound files that sound truly human, dramatically increase the productivity of Web designers while improving the product and help analyze data to improve marketing. Since Adobe Systems is now cloud-based, this is not an add-on product, but another reason to maintain subscriptions on existing products.

The Bottom Line on ADBE Stock

ADBE stock is pricey. But, as the success of Nvidia proves, the whole concept of “graphics” is changing in our time. It’s not just about pictures, it’s about faster analysis of all data.

This puts Adobe Systems Incorporated in a very sweet spot. It can deliver new capabilities quickly, and open new markets effortlessly.

The question for me remains the price, and the strength of the market. If the market falls, momentum stocks like Adobe will fall hardest, and fastest. Most macro analysts see happy days for 2018, but I’m not one of them.

Again, if you have time to wait for a recession to clear and for the next recovery to begin, Adobe is a great stock to buy now. If you can’t do that, avoid it.

Dana Blankenhorn is a financial and technology journalist. He is the author of the historical mystery romance The Reluctant Detective Travels in Time, available now at the Amazon Kindle store. Write him at danablankenhorn@gmail.com or follow him on Twitter at @danablankenhorn. As of this writing he owned no shares in companies mentioned in this article.

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