Jan 19 2020 - Adobe: Don't Chase The Stock Here

Summary

Adobe was up over 40% last year, outperforming both the S&P-500 and the Nasdaq Composite.

The company's earnings trend remains strong, with double digit annual EPS growth expected for FY-2020.

While the fundamentals remain strong, the stock is beginning to get overbought at current levels, more than 25% above its 20-month moving average.

Based on this, I believe investors would be wise not to chase the stock at current levels.

Adobe (ADBE) had yet another exceptional year in 2019 with a 40% return, managing to easily outperform both the S&P-500 (SPY) and the Nasdaq-100 Index (QQQ). This marked the stock's third year in a row of a 1000 basis point or better outperformance vs. the S&P-500, with the stock now up over 390% since the cyclical bear market ended in February 2016. Adobe's earnings trend continues to remain healthy, as does top-line growth, with strong double-digit annual EPS growth expected for FY-2020. However, the stock is beginning to get a little overbought at 9.00, making the stock more susceptible to a 10-20% correction. Given this fact, I believe investors would be wise to wait for a pullback before adding any new exposure.

(Source: TC2000.com)

Last year was yet another incredible year to be a shareholder in Adobe, with the stock trouncing the performance of the major averages, and not missing a beat to start the new year. The stock is up 6% thus far in 2020, adding to its 45% gain in 2019, helped by coming off of robust fiscal Q4 2019 report. Not only did Adobe manage to put up a top-line beat of .8 million, nearly 1% above estimates, but they also returned significant cash to shareholders, repurchasing 2.8 million shares at an average price of 5.36. This should continue to help drive annual EPS growth, with a 0.5% lower share count this quarter alone, bought back at attractive prices. Let's take a closer look at the company's growth metrics below:

As we can see in the below chart of annual earnings per share [EPS], Adobe has been an earnings powerhouse, having grown annual EPS from .33 in FY-2013 to .87 in FY-2019. Even more impressive, the company's annual EPS growth rate is expected to accelerate in FY-2020 to 25%, a 900 basis point improvement from the 16% growth rate in FY-2019. This is incredible growth for a mega-cap that's already managed to more than quintuple annual EPS in six years and will give the company a seat among the top earnings growers among large caps for FY-2020.

(Source: YCharts.com, Author's Chart)

As legendary investor William O'Neil has pointed out in the "A" of his CANSLIM criteria, the best growth companies with the most outstanding performance managed to consistently grow annual EPS at a rate of 24% or more. Given the current earnings estimates for Adobe in FY-2020 of 25%, the stock is one of the only mega-caps to hold this esteemed title heading into the new year. If we compare this to other mega-caps, Microsoft's (MSFT) annual EPS growth for FY-2020 is estimated at 13%, SalesForce.com's yearly EPS growth for FY-2020 is forecasted at 13%, and Mastercard's (MA) is 18%. Therefore, Adobe has one of the most impressive annual EPS growth rates among its mega-cap peers. To summarize, from an earnings trend standpoint, Adobe is one of the clear leaders, and still has a strong runway for growth.

Moving over to quarterly revenue growth rates, Adobe reported revenues of .99 billion in fiscal Q4 2019, translating to 21% growth year-over-year. While this marked a 300 basis point sequential deceleration from fiscal Q3 2019, this slowdown isn't enough that I would consider it to be alarming. However, it is a 2-year low for quarterly revenue growth. If we look forward to fiscal Q1 2020, revenue estimates are currently forecasting .06~ billion in revenue, translating to only 18% growth year-over-year. This would mark yet another quarter of sequential deceleration, and would mark yet another new low for revenue growth rates. Ideally, investors are going to want to see a minimum of .14 billion to prevent further deceleration. However, this would require a top-line beat of nearly million vs. estimates, a far cry from the near million beat on estimates last quarter.

(Source: YCharts.com, Author's Chart)

If we take a look at the chart below showing quarterly revenue growth rates, it's evident that Adobe is likely to see some slowdown as we head into FY-2020. Based on current estimates, FY-2020 revenue will be lucky to come in above 20%, a slight step down from the 24% revenue growth rate in FY-2020. I would not consider this lower revenue growth rate a severe issue for Adobe, but it is a minor headwind as the stock heads into FY-2020. This is because Adobe had exceptional earnings growth with stable revenue growth rates in FY-2018 and FY-2019. For FY-2020, however, Adobe will have robust earnings growth with declining revenue growth rates, barring some gargantuan top-line beats.

Given that the highest quality growth stocks have accelerating or stable revenue growth, this is a slight knock against Adobe here on a fundamental basis. Unless Adobe can report revenues of .14 billion for fiscal Q1 2020, this will be the first time in nearly three years that both the quarterly revenue growth rate and two-quarter average revenue growth rate (white line) slow for two consecutive quarters. To summarize, while the earnings trend looks exceptional, Adobe leaves a little to be desired in FY-2020 when it comes to top-line growth. Based on this, I see the stock as more of a Hold vs. a buy at current levels, as it's harder to justify paying up for the stock when there's the risk of sequential deceleration on the horizon.

(Source: YCharts.com, Author's Chart)

Moving over to the technical picture, Adobe continues to trade in a strong uptrend but is now nearly 25% above its 20-month moving average (green line). While this is not an extremely overbought signal, further upside from these levels short-term has generally led to consolidations or corrections of 10% or more. Therefore, this is not an ideal spot to be adding exposure. Instead, the best time to be adding exposure to Adobe has been on 10% pullbacks towards the 20-month moving average, not when it's already 25% above it. Based on this, while I do not believe investors should cash out here, I think a better entry will be ahead later this quarter or early in Q2.

(Source: TC2000.com)

Finally, from a valuation standpoint, Adobe is getting expensive at current levels. The 16x price to sales ratio has been a brick wall for the stock for over 20 years now, with the most recent major peak for the stock occurring at just over 16x price to sales in August 2018. While the general market weakness exacerbated much of the correction following this valuation, Adobe has a decelerating revenue growth rate heading into this valuation vs. a stable revenue growth rate at the time of the August 2018 peak. Therefore, the stock is at a similar valuation, but with a less impressive revenue growth rate, and a slowdown on the horizon. Given this fact, it's hard to argue for adding any exposure at only 5% below a significant resistance level for the stock from a valuation standpoint.

(Source: YCharts.com)

Adobe is arguably one of the most impressive growth stocks in the mega-cap space; however, a lofty valuation, a high likelihood of further sequential deceleration in top-line growth and a semi-extended chart have made the stock unattractive currently. I do not believe this justifies liquidating positions for investors, but I see this as a terrible spot to be rushing to add new exposure above 9.00. Adobe is already beginning to get expensive at a revenue multiple of 15.4, and the stock is heading into a quarter where it won't be very easy to prevent top-line deceleration. In summary, I see Adobe as a Hold at current levels, but believe both investors and traders would be wise to be patient before adding any new exposure here.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Disclaimer: Taylor Dart is not a Registered Investment Advisor or Financial Planner. This writing is for informational purposes only. It does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Taylor Dart expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.

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