Is Adobe a Sell?

Should you sell Adobe (Nasdaq: ADBE  ) today?

The decision to sell a stock you've researched and followed for months or years is never easy. If you fall in love with your stock holdings, you risk becoming vulnerable to confirmation bias -- listening only to information that supports your theories, and rejecting any contradictions.

In 2004, longtime Fool Bill Mann called confirmation bias one of the most dangerous components of investing. This warning has helped my own personal investing throughout the Great Recession. Now, I want to help you identify potential sell signs on popular stocks within our 4-million-strong Fool.com community.

Today I'm laser-focused on Adobe, ready to evaluate its price, valuation, margins, and liquidity. Let's get started!

Don't sell on price
Over the past 12 months, Adobe is down 19.2% versus an S&P 500 return of 11.3%. Investors in Adobe are no doubt disappointed with their returns, but is now the time to cut and run? Not necessarily. Short-term underperformance alone is not a sell sign. The market may be missing the critical element of your Adobe investing thesis. For historical context, let's compare Adobe's recent price to its 52-week and five-year highs. I've also included a few other businesses in the same or related industries:

Company

Recent Price

52-Week High

5-Year High

Adobe

$28.36

$38.20

$48.50

Autodesk (Nasdaq: ADSK  )

$35.52

$36.64

$51.30

CA Technologies (Nasdaq: CA  )

$23.19

$23.91

$29.70

Microsoft (Nasdaq: MSFT  )

$25.31

$31.58

$37.50

Source: Capital IQ, a division of Standard & Poor's.

As you can see, Adobe is down from its 52-week high. If you bought near the peak, now's the time to think back to why you bought it in the first place. If your reasons still hold true, you shouldn't sell based on this information alone.

Potential sell signs
First up, we'll get a rough idea of Adobe's valuation. I'm comparing Adobe's recent P/E ratio of 31.6 to where it's been over the past five years.

Source: Capital IQ, a division of Standard & Poor's.

Adobe's P/E is lower than its five-year average, which could indicate the stock is undervalued. A low P/E isn't always a good sign, since the market may be lowering its valuation of the company because of less attractive growth prospects. It does indicate that, on a purely historical basis, Adobe looks cheap.

Now, let's look at the gross margins trend, which represents the amount of profit a company makes for each $1 in sales, after deducting all costs directly related to that sale. A deteriorating gross margin over time can indicate that competition has forced the company to lower prices, that it can't control costs, or that its whole industry's facing tough times. Here is Adobe's gross margin over the past five years:

Source: Capital IQ, a division of Standard & Poor's.

Despite a dip from 2005 levels, Adobe is having no trouble maintaining its gross margin, which tends to dictate a company's overall profitability. This is solid news; however, Adobe investors need to keep an eye on this over the coming quarters. If margins begin to dip, you'll want to know why.

Next, let's explore what other investors think about Adobe. We love the contrarian view here at Fool.com, but we don't mind cheating off of our neighbors every once in a while. For this, we'll examine two metrics: Motley Fool CAPS ratings and short interest. The former tells us how Fool.com's 170,000-strong community of individual analysts rate the stock. The latter shows what proportion of investors are betting that the stock will fall. I'm including other peer companies once again for context.

Company

CAPS Rating (out of 5)

Short Interest (% of Float)

Adobe

3

3.2

Autodesk

4

3.0

CA Technologies

2

1.8

Microsoft

3

0.9

Source: Capital IQ, a division of Standard & Poor's.

The Fool community is in the middle of the road on Adobe. We typically like to see our stocks rated at four or five stars. Anything below that is a less-than-bullish indicator. I highly recommend you visit Adobe's stock pitch page to see the verbatim reasons behind the ratings.

Here, short interest is at a mere 3.2%. This typically indicates few large institutional investors are betting against the stock.

The last metric I like to look at is the current ratio, which lets investors judge a company's short-term liquidity. If Adobe had to convert its current assets to cash in one year, how many times over could the company cover its current liabilities? As of the last filing, Adobe has a current ratio of 3.35. This is a healthy sign. I like to see companies with current ratios equal to or greater than 1.5.

Finally, it's highly beneficial to determine whether Adobe belongs in your portfolio -- and to know how many similar businesses already occupy your stable of investments. If you haven't already, be sure to put your tickers into Fool.com's free portfolio tracker, My Watchlist. You can get started right away by clicking here to add Adobe.

The final recap

Adobe has failed only one of the quick tests that would make it a sell. This is great, but does it mean you should hold your Adobe shares? Not necessarily. Just keep your eye on these trends over the coming quarters.

Remember to add Adobe to My Watchlist  to help you keep track of all our coverage of the company on Fool.com.

If you haven't had a chance yet, be sure to read this article detailing how I missed out on over $100,000 in gains through wrong-headed selling.

Jeremy Phillips does not own shares of the companies mentioned.

Microsoft is a Motley Fool Inside Value recommendation. Adobe Systems is a Motley Fool Stock Advisor pick. The Fool owns shares of and has written covered calls on Autodesk. Motley Fool Options has recommended a diagonal call position on Adobe Systems. Motley Fool Options has recommended a diagonal call position on Microsoft. The Fool owns shares of Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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  • Report this Comment On December 01, 2010, at 7:50 PM, cogitate4u wrote:

    What about their $1.8b acquisition of Omniture last year, what impact (if any) did that have on their overall product portfolio and related share price?

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