Editor’s note: This article is a part of InvestorPlace.com’s Best Stocks for 2019 contest. John Jagerson and Wade Hansen’s pick for the contest is Adobe (NASDAQ:ADBE).
Some companies created brands that became synonymous with their products. I could tell someone to Xerox a document, take a Polaroid, hand me a Kleenex, etc.
Back in the 90s, if I wanted to design computer graphics, I used Adobe (NASDAQ:ADBE). I dare you to think of any program from 10 years ago that could open a PDF file other than Adobe Acrobat. That dominance has continued as the company has adjusted and thrived in the cloud space.
Adobe Stock Has Fundamental Outperformance
Three main segments comprise Adobe’s business: Digital Media, Digital Expertise and Publishing.
The media segment includes its “Creative” products, like Photoshop (which many of us are familiar with) and its document services, and accounts for 70% of the company’s revenue.
The expertise segment (27% of revenues) is focused on digital marketing and web analytics. If you ever wondered who makes some of the tools that “track” your online movements to target your advertising — now you know.
As the company has shifted further into the cloud in both its media and expertise businesses, revenues have climbed 15% during the last three years.
At the same time, gross margins expanded from 84.5% in 2015 to 87.1% over the last 12 months. More impressive, net margins increased from 18.9% to 32.3% during the same period.
The real engine that drove this growth has been the creative revenues. This business, which includes cloud subscription services, digital publishing suite contracts and creative contracts, grew from $3.18 billion in 2016 to $4.17 billion in 2017.
After three quarters, this segment already hit $3.89 billion in 2018 and will likely end up near $5 billion by the end of the year. If you have ever purchased a license to Photoshop, Premier or InDesign, you are already familiar with the kind of products ADBE is licensing through subscriptions to broaden its client base and increase margins.
The opportunity in this case is that, despite recent growth and future estimates, ADBE’s earnings multiple, or price-to-earnings ratio, has been falling as investors were distracted by trade issues and interest rates. As you can see in the following chart, this is the most undervalued earnings multiple since the stock was priced at $100 per share.
A Bullish Technical Setup for ADBE Stock
Along with nearly every stock of note, Adobe saw its share price nosedive on Nov. 19. The Nasdaq 100 index took it on the chin more than other markets.
Adobe wasn’t spared, as the stock completed a bearish “head and shoulders” pattern in November. However, ADBE has rebounded back through the previous pivot level/neckline of the pattern, which we expect to act as support going forward.
A sustained rally through $254 would complete a small, bullish inverted “head and shoulders” pattern, which has a great track-record during bull markets.
Although this may not feel like a skyrocketing market, the underlying fundamentals are still very positive, so we would put the odds strongly in favor of a continuation to the upside just before or after the first of the year.
A Few Issues to Watch
A quarter of Adobe’s sales come from Europe, so Adobe may see its revenues soften — especially in document services — if the European economy continues to weaken and the “Brexit” situation gets worse.
The company’s continual investment in developing end-to-end document signing and processing puts it at the forefront of the global supply chain. However, recent trade wars could stall that income growth in the short term.
While these issues are concerning, they are systemic rather than specific to ADBE itself. Alternative investments may have more or less exposure to Europe and trade, but significant deterioration in the global economy will affect all stocks.
Although ADBE isn’t considered a “defensive” stock, its cash flow and margin growth should make it relatively attractive if the market falters again in 2019.
InvestorPlace advisers John Jagerson and S. Wade Hansen, both Chartered Market Technician (CMT) designees, are co-founders of LearningMarkets.com, as well as the co-editors of Strategic Trader.
For much more in-depth market research and individual stock analysis just like this — and to get access to our full portfolio of income-generating trades — consider signing up for risk-free trial subscription to Strategic Trader today.