U.S. Markets close in 3 hrs 59 mins

You’ll Have to Weather the Chop to Get the Pop in Adobe Systems Incorporated

Josh Enomoto

Among technology companies, Adobe Systems Incorporated (NASDAQ:ADBE) is about as automatic as you can get. Year-to-date, ADBE stock is up a robust 46%, and for good reason. Adobe products form the backbone of multimedia operations, ranging from the ubiquitous Photoshop to PDF files. But recently, shares have entered a rough patch. Should investors hold on, or is this ride done? For now, the general consensus is positive.

You'll Have to Weather the Chop to Get the Pop in ADBE

Source: Shutterstock

Of the 30 analysts covering ADBE stock this month, only one is outright bearish, while four maintain a hold rating. Everyone else is either bullish or exceptionally bullish. Most market participants view Adobe’s recent decline as a minor technical blip. The recent ADBE earnings report, for example, was solid and gave no indication that investors should worry.

Still, the markets reacted poorly to the ADBE earnings. It wasn’t until September 25, or four business days after the report, that ADBE stock finally hit a bottom. InvestorPlace contributor Dana Blankenhorn initially reported the pessimistic price action, but expected shares to regain traction. For a while, Adobe did exactly that. But trading over the past few days has been pensive, accentuated by a 2.3% loss to start the week of October 16.

InvestorPlace - Stock Market News, Stock Advice & Trading Tips

How should investors handle Adobe moving forward? On the ADBE news front, nothing indicates that the company is troubled; in fact, it’s quite the opposite. At the same time, ADBE stock isn’t cheap, priced at 47 times trailing earnings. The average price-earnings ratio for global software companies is 27 times trailing earnings.

While PEs aren’t the end-all and be-all, they’re a reasonable valuation indicator under certain circumstances. Hitting all-time highs in the markets qualifies, which likely sent traders scrambling to take profits. Will that selling pressure continue?

Smart Decisions Keep ADBE Firmly in the Game

I agree with many of my colleagues that the long-term prospect for ADBE stock is favorable. Over the years, Adobe transitioned from a software provider to one that offers Software as a Service, or SaaS. This subscription-based service has had a profound effect on the company. As our own Luke Lango explains:

“Adobe is king in the creative content world. No one really comes close to Adobe’s Creative Cloud in terms of offering a one-stop shop for creative professionals to create, edit and amplify visual content.”

The software firm’s foray into cloud computing puts it into elite company, alongside names like Microsoft Corporation (NASDAQ:MSFT), Amazon.com, Inc. (NASDAQ:AMZN) and International Business Machines Corp. (NYSE:IBM). A key difference for Adobe, though, is that it doesn’t necessarily have a contentious relationship with other cloud members.

As Blankenhorn notes, Adobe’s SaaS applications are hosted on Microsoft’s Azure network. Furthermore, Microsoft’s Office 365 works seamlessly with specific Adobe programs. Thus, as Microsoft gains traction on its SaaS, it will likely lift Adobe integration.

More importantly, the SaaS platform addresses content creators’ bane — piracy. Initial attempts to combat software piracy were ineffective. Researchers from leading British universities discovered that punitive measures (such as fines and incarceration) had little impact on changing behaviors. Instead, it’s more effective to offer a quick, cheap and easy platform to take the teeth out of digital piracy.

The reason we don’t hear too much about illegally distributed software in the latest ADBE news is the lack of incentive. For a reasonable monthly fee, subscribers have access to all the latest Adobe programs. No longer do they have to grit through outdated software. Therefore, at a certain point, risking serious fines or jail time isn’t worth it.

Watch Out for Near-Term Turbulence

While I am bullish, I have to issue a caveat. Yes, Adobe implemented smart strategies into its business, and ADBE news items offer strong tailwinds. However, the markets have the last say, and unfortunately, ADBE stock doesn’t look too hot right now.

Monday’s gap down below its 50-day moving average confirms that traders are still profit taking. That’s not a problem in the longer-term perspective, but in the near term, we should expect some volatility. Upwardly revised earnings and sales forecasts pushes Adobe to the limit. Somewhere along the line, the company will fall short of these exaggerated targets.

Market participants are anticipating this failure and are hedging themselves accordingly. We can also expect to see a self-fulfilling prophecy: as the Adobe share price weakens, it will spark increasing profit taking. This will go on until the nonsense stops.

Naturally, I think this is a buying opportunity for ADBE stock, and I’m not the only one who believes this. Still, I do want to warn that Adobe could be a choppy ride for a few weeks. But those who have the nerve to hold on through the coming storm should be quite pleased afterwards.

As of this writing, Josh Enomoto did not hold a position in any of the aforementioned securities.

More From InvestorPlace

The post You’ll Have to Weather the Chop to Get the Pop in Adobe Systems Incorporated appeared first on InvestorPlace.