Should Investors Buy Adobe?

Despite Monday’s 4% drop in Adobe's ADBE stock price, the stock remains roughly 45% above its March low. Our research suggests this stock has a lot more room to run over the next several months.

Dating back to the late 1990s, ADBE’s stock (adjusted for dividends and splits) has been correlated with the 12-month rate-of-change of software pricing power (note: we show consumer software prices as a proxy for overall software prices, i.e. business and consumer products). However, since last September ADBE’s stock price has diverged from software prices, a trend that we expect will reverse in coming quarters given the firm’s decent business prospects.

Software prices should stay resilient, especially relative to overall prices. The main reason for this resilience is that businesses typically do not cut software spending as much as other expenses during recessions given software improves productivity which will help maintain a lid on costs.

Our proprietary Ranking System rates Adobe as a Strong Buy. One of the main reasons for this optimism is that the Ranking System typically favors stocks with high free cash flows (among other factors) and Adobe fits this bill.

Interestingly, the chart below reveals that Adobe’s long-term price trend is correlated with its free cash flow per share. However, due to the overall market collapse, Adobe’s stock declined substantially last year. Yet this decline may not reflect the stock’s financial and business conditions. As markets stabilize (assuming they do this year), we expect Adobe’s stock to play catch-up with its fundamentals.

Note: “”LS” = Left Scale, “RS” = Right Scale

We recommend investors buy Adobe’s stock. However, readers should understand that the arguments presented above represent just two angles (future pricing power and strong free cash flows). Investors seriously considering buying this stock should explore all risk factors to determine if owning Adobe meets their risk and return objectives.

Disclosure: No Positions.