If Adobe (NASDAQ:ADBE) stock were the only investment in your portfolio, you’d be up about 20% so far for the year. On June 5, ADBE stock reached an all-time high of $396.17. It has clearly outperformed the market in 2020.
The software specialist has been in business close to four full decades. The 1980’s marked the early days of desktop PC software. During most of those years, it was a boxed-and-licensed software company. But over the past decade, the San Jose, California-based company has transformed itself to a cloud computing and software-as-a-service provider with a recurring revenue model. As a result of this subscription-based business model, revenue and earnings have become relatively predictable.
As the digital media and marketing software maker gets ready to report earnings on June 11, investors are now wondering if they should now be taking some of their profits off the table. Although I believe Adobe is a great long-term investment, ADBE stock is likely to be choppy in the coming days with some downward pressure. Depending on your portfolio’s risk/return profile, you may want to either ring the cash register or ride out the potential volatility. Let’s see why.
What to Expect from Q2 Earnings
Adobe last reported earnings on March 12, i.e., before the country went into the novel coronavirus lockdown. Q1 results topped earnings and revenue estimates, with an adjusted $2.27 a share on sales of $3.09 billion in the period. Earnings and sales grew by 33% and 19% YoY, respectively. Cash flow generation was also solid.
CEO Shantanu Narayen, who has led Adobe since 2007, told a March 12 conference call that the group expected “some enterprises will delay bookings, postponed services implementation and reduce expenses” as a result of COVID-19 developments.
Looking ahead to this week when Adobe reports Q2 results on June 11, investors are likely to pay attention to several metrics. It reports revenue in three segments:
- Digital Media (offers creative cloud and document cloud services. Subscribers download products such as Photoshop and Acrobat family of products);
- Digital Experience (provides solutions, including analytics, social marketing, and media optimization);
- Publishing (includes e-learning solutions, technical document publishing, and high-end printing).
The Digital Media segment is more than twice the size of its Digital Experience. Publishing contributes only about 1% of the total revenue. And within Digital Media, Creative Cloud is its biggest money maker.
Last quarter saw the third-straight quarter of accelerating earnings growth for Adobe.
The group also divides revenue by geography:
- Americas (in Q1, about 59% of revenue)
- EMEA (in Q1, about 26% of revenue)
- APAC (in Q1, about 15% of revenue)
Investors will be interested to know how the stay-home and work-from-home trends could be affecting the revenue in total as well as by segment and geography. If the new economy has brought further growth opportunities across segments or geographies, then the Street is likely to put its seal of approval on the results.
What Could Derail ADBE Stock in the Short Run?
Profit-taking: Adobe is a well-managed company with a strong cloud-based, subscription-revenue model. And its share price may be a strong testament for the long-term outlook for the group. In 2011, it was around $20. Now, it is flirting with $400.
In mid March, Adobe shares hit a 52-week low of $255.13. Since then ADBE stock is up over 55%. Therefore, it’d be reasonable to expect some profit-taking around the earnings release date. Put another way, much of the good news that may come out of the quarterly results may already be priced into the shares.
Are you an investor who also watches technical charts? Then you may be interested to know that ADBE stock’s short-term technicals are showing an overbought territory.
Although a stock can stay overbought for quite some time, a change in investor sentiment could cause the price to drop quite fast, too.
On the upside, I expect $400 to act as resistance. In case of a near-term profit-taking, my first target would be $380 or even $360. Although long-term traders would like to see the price go above and stay over $400, short-term traders are likely to keep it between $375 and $400 for now.
High valuation: Adobe’s forward P/E and P/S sales ratios stand at 39.8 and 16.5, respectively. These are on the high end, even for a solid company like Adobe.
The recent rally we’ve witnessed in broader markets, especially in tech stocks, for the most part reflects the belief in a V-shaped recovery for our economy. However, if there were an upcoming change in investor sentiment on the rebound’s prospects, then these stock valuations would come down fast and expensive tech stocks would likely be hit the hardest.
Seasoned investors realize that the price of fundamentally strong growth stock such as ADBE in general carries a premium. Yet, if you also believe that the share price may have become overvalued for now, you may want to look for opportunities in other solid names in the market.
Investor Takeaway on Adobe Stock
Adobe has the products to get the customers to subscribe and management knows how to keep those subscribers loyal. Subscription revenue now represents 90% of total revenue. The group’s financials are robust. Over the past decade, it has had stable earnings growth and superior price performance.
Since the lows seen in mid-March, ADBE stock has roared all the way back to all-time highs. Therefore some short-term profit-taking is likely to be around the corner. If you are a short-term investor, you may want to consider de-risking at this point.
Alternatively, you may also consider hedging your position with covered calls. For example, July 17 expiry ATM calls would decrease portfolio volatility and offer investors some downside protection. It’d also enable investors to participate in a potential up move following the earnings release.
Finally, those who do not own ADBE stock may consider buying into the company at any upcoming dip. After all, investors love buying a growth stock at a discount.
Tezcan Gecgil has worked in investment management for over two decades in the U.S. and U.K. In addition to formal higher education in the field, she has also completed all 3 levels of the Chartered Market Technician (CMT) examination. Her passion is for options trading based on technical analysis of fundamentally strong companies. She especially enjoys setting up weekly covered calls for income generation. As of this writing, Tezcan Gecgil did not hold a position in any of the aforementioned securities.
