Why I Just Can't Get Behind Adobe

More than anything else, managers determine returns. They set strategy, hire key team members, oversee operations, and cash paychecks. Every move they make either enhances or destroys shareholder capital.

It pays to know who these men and women are, how they're paid, whether they, too, are owners, and how they perform versus competitors in certain key metrics. In this regular column, I'll examine all that and more with the goal of enhancing our understanding of some of the top stocks in Fooldom.

Next up: Adobe Systems (Nasdaq: ADBE  ) . Is the executive team of this maker of web and publishing software doing all it can to earn you outsized returns?

Foolish facts

Metric

Adobe Systems

CAPS stars (out of 5) ***
Total ratings 1,986
Percent bulls 94.9%
Percent bears 5.1%
Bullish pitches 325 out of 344
Highest rated peers SinoHub, Ansys, Tyler Technologies

Data current as of March 20.

Adobe is a lightning-rod stock. Some Fools love it. Others hate it. What no one disputes is the size and quality of Adobe's historic software franchises. Stop me if you've heard these names before:

  • Photoshop
  • Acrobat
  • Illustrator
  • Reader
  • PageMaker
  • Flash

Bullish investors love this list. They love that creatives and web developers take to Adobe's tools like a moths to a lamplight. The company's massive installed base is what helps it to consistently throw off more than $1 billion in cash from operations annually.

Even so, detractors will tell you that Adobe's web-based technology is inefficient. I know what they mean. Consider AIR. Running Graphic.ly's comic book reader in my Chrome browser creates virtually zero strain on my Mac. Not so with the AIR version.

Even with the Meebo IM client and my Google apps open, Chrome with Graphic.ly accounts for less than 10% of my Mac's processing workload. By contrast, the AIR-based version accounts for more than 20% routinely. And that's low compared to my experience with AIR-based social media platforms, such as TweetDeck.

Developers and users aren't the only ones frustrated with Adobe, and more specifically, Flash. Partners are, too. Apple (Nasdaq: AAPL  ) CEO Steve Jobs famously skewered Flash in an open letter last year while Google (Nasdaq: GOOG  ) and Microsoft (Nasdaq: MSFT  ) have both backed HTML5 over Flash for video playback.

Management overview

Executive

Years

Cash Compensation

Shares Owned*

John Warnock, Co-Founder and Co-Chairman 29 $100,000 1,140,821
Charles Geschke, Co-Founder and Co-Chairman 29 $100,000 224,500
Shantanu Narayen, President and CEO 13 $3,069,842 204,818
Mark Garrett, Chief Financial Officer 4 $1,599,758 57,384

Source: Capital IQ, a division of Standard & Poor's. (Data current as of March 14.)
* Includes shares set aside for the Geschke and Warnock family trusts

If you have to go head-to-head with some of the largest companies in tech, it's best to do so with managers who are experienced and which have plenty to lose if business turns sour. Adobe has plenty of experience, yet insider ownership interests have dwindled.

Form 4 Oracle reports that Adobe executives and board members have sold nearly $5 million worth of stock on the open market over the past year. CEO Narayen was the most recent seller. His family trust cashed in more than 66,000 shares in January, collecting $2.2 million in proceeds.

But as the table above shows, stock sales aren't where Narayen makes his money. His millions in salary and bonus guarantee him a comfortable living, regardless of what happens to the stock. Not exactly the arrangement I'd want as an investor.

Management analysis versus competitors

Company

Insider Ownership

Gross Margin

ROC*

ROE**

Adobe Systems 0.45% 89.4% 10.1% 15.4%
Apple 0.70% 38.8% 29.7% 36.8%
Microsoft 4.04% 79.2% 31.1% 44.3%
Nuance Comms. (Nasdaq: NUAN  ) 1.05% 67% 1.6% (0.7%)

Source: Capital IQ, a division of Standard & Poor's. (Data current as of March 14.)
* Return on capital.
** Return on equity.

Perhaps the worst part of the Adobe story is how it compares to Microsoft. Both companies have significant, long-lasting software franchises. Both have high gross margins. Both feature tenured management. And yet Mr. Softy produces sharply higher returns on capital and equity than its smaller peer.

Were you to force me to choose between the two, I'd take Microsoft. But it probably says more that I already own shares of Apple and Google while I've avoided Adobe and Microsoft. I'd rather bet on the two businesses most responsible for the cloud-driven mobile computing era we're entering into.

Do you agree? Disagree? Let us know what you think about Adobe's products, strategy, and valuation using the comments box below. You can also rate Adobe in Motley Fool CAPS. Finally, don't forget to keep tabs on Adobe Systems by adding the stock to Your Watchlist for free, personalized stock tracking.

Google and Microsoft are Motley Fool Inside Value picks. Google is also a Motley Fool Rule Breakers recommendation. Adobe Systems, Apple, and Nuance Communications are Motley Fool Stock Advisor selections. Nuance is also a Motley Fool Hidden Gems pick. Motley Fool Options has recommended members open a bull call spread position in Apple and diagonal call positions in Adobe and Microsoft. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Tim Beyers is a member of the Rule Breakers stock-picking team. He owned shares of Apple and Google at the time of publication. Check out Tim's portfolio holdings and Foolish writings, or connect with him on Twitter as @milehighfool. You can also get his insights delivered directly to your RSS reader. 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 owns shares of Apple, Google, and Microsoft and has written Apple puts. The Fool is also on Twitter as @TheMotleyFool and its disclosure policy is managing just fine, thanks.


Read/Post Comments (2) | Recommend This Article (2)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 21, 2011, at 3:45 PM, Henry3Dogg wrote:

    Flakey is GREAT for pastry.

    Software should be robust.

  • Report this Comment On March 21, 2011, at 4:57 PM, deemery wrote:

    I'm suspicious of judging management by the short term metric of stock prices, and in particular I'm very leery of trying to motivate executives through stock options that don't force a long-range view. It's WAY too easy to loot a company driving up the short term stock price, leaving a hollow shell after the executives cash out.

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