I'm a believer in growth stocks. As an analyst for our Motley Fool Rule Breakers service, I think you should be a believer too. But even I have to admit some growth stories are bogus, hence this regular series.

Next up: Adobe Systems (Nasdaq: ADBE). Would it make sense for Microsoft (Nasdaq: MSFT) to buy this maker of graphics and web software, as the rumor mill is suggesting? Let's get right to the numbers.

Foolish facts


Adobe Systems

Motley Fool CAPS stars (out of 5) ***
Total ratings 2,076
Percent bulls 94.9%
Percent bears 5.1%
Bullish pitches 339 out of 363
Highest rated peers Intuit, Nuance Communications, Autodesk (Nasdaq: ADSK)

Data current as of Oct. 8.

For those who didn't see the headlines yesterday, analysts and talking heads took to the web and television to report that Mr. Softy was mulling a bid for Adobe, sending the shares 11% higher on the day. The stock is giving back some of those gains as I write this.

Technically, there's merit to this combination. Microsoft has been slow to adopt the HTML5 standard that both Apple (Nasdaq: AAPL) and Google (Nasdaq: GOOG) back, remaining mostly supportive of Adobe's Flash video playback system while also creating its own, called Silverlight. Combining them under one roof would give Mr. Softy a hammerlock on video playback technology as the transition to HTML5 continues.

Also, it could allow Microsoft to distinguish its phones and tablets as compatible with standards that Apple, in particular, has been lax to support. (Namely, Flash and Silverlight.)

So a deal could make sense, but at what price? Adobe's closed at $28.69 a share, for an implied market cap of roughly $14.9 billion. Microsoft CEO Steve Ballmer certainly has the ability to pay that much, but should he? I'm not convinced.

The elements of growth


Last 12 Months



Normalized net income growth (0.6%) (30.6%) 16.3%
Revenue growth 14.4% (17.7%) 13.4%
Gross margin 89.3% 89.9% 89.9%
Receivables growth 71.9% (12.1%) 46.9%
Shares outstanding 518.7 million 522.7 million 526.1 million

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

Why? This table shows growth in all the wrong places. Let's review:

  • First, gross margin, while high, is declining. Adobe may be losing its once-vaunted pricing power in key areas such as graphic design software.
  • Revenue growth has returned, thankfully, but earnings growth hasn't. It's as if the untold millions Adobe has spent on share buybacks has had no effect.
  • Finally, receivables are growing far faster than revenue, just as margins are declining. This suggests discounting, which only works when you're the low-cost provider. Historically, cheap software hasn't been Adobe's forte.

Competitor and peer checkup


Normalized Net Income Growth (3 yrs.)

Adobe 2%
Apple 55%
Autodesk (18.8%)
Eastman Kodak (NYSE: EK) 25.7%
Google 25%
Microsoft 8.1%
Yahoo! (Nasdaq: YHOO) (3.6%)

Source: Capital IQ. Data current as of Oct. 7.

We don't need to say much here, do we? Adobe ranks among the industry laggards, despite its market-leading position in video-playback technology and graphic-design software. Barring a breakthrough innovation, the stock appears fairly valued, at best.

Grade: Unsustainable
But I don't expect valuation to stop Microsoft. The competitive dynamics of the smartphone and cloud-computing markets have forced Mr. Softy to suit up for battle, and the company's $36 billion war chest is one of its chief weapons. Acquiring Adobe at a premium may be the company's only logical move -- if, that is, regulators were inclined to approve such a deal, which they may not be.

Either way, I don't like Adobe at these levels. There's too much speculation and not enough competitive advantage. As a result, I'm making a short-term underperform call on the stock in my CAPS portfolio.

Now it's your turn to weigh in. Do you like Adobe Systems at these levels? Let the debate begin in the comments box below. You can also ask Tim to evaluate a favorite growth story by sending him an email, or replying to him on Twitter.

True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community.

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

Fool contributor Tim Beyers is a member of the Motley Fool Rule Breakers stock-picking team. He had stock and options positions in Apple and a stock position in 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. The Motley Fool owns shares of Apple, Google, and Microsoft and is also on Twitter as @TheMotleyFool. Its disclosure policy thinks Monty Python is sustainably funny.