Adobe Looks Headed for a Suite Spot

I jumped the gun.

In September 2007, I waxed positive on Adobe (ADBE - commentary - Cramer's Take) after an impressive third-quarter earnings report. Since then, the stock has fallen 27% compared with a 12.4% drop in the S&P 500.

Given my propensity to enter positions by writing puts (which I also discussed in that article), I actually fared somewhat better than that. After one set of puts expired worthless, my November $42.50s were exercised against me. My effective purchase price (including put option premiums received) is about $40 per share.

As they say, there is little difference between being early and being wrong. Checking back on the investment thesis, however, I still feel confident about Adobe's prospects for the remainder of 2008. In fact, I'd argue that the stock is about to enter its "suite spot." Creative Suite 4, that is.

From what I have observed, Adobe's price-to-earnings multiple usually rises into the mid-30s immediately ahead of a major new product release, then retreats to the mid-20s afterward. The last such release was in May 2007, and as if on cue, the P/E multiple has been contracting ever since.

Rising on Anticipation

The anticipation rallies tend to be quite attractive. In the 10 months between July 2006 and the release of Creative Suite 3, Adobe rose 54%, from $28.50 to $44.00. Similarly, between July 2004 and the May 2005 Creative Suite 2 release, the stock surged 57%, from $21.00 to $33.00. Finally, during the 10 months prior to the original Creative Suite launch in October 2003, the stock jumped 77%, from $12.36 to $21.84.

Given Adobe's typical 18-to-24-month product cycle, however, I would expect the next version to be released late this year or in early 2009. So although Adobe raised its guidance for the fiscal year ending in November to a range of $1.86 to $1.92 per share (compared with consensus estimates of $1.82), it is unlikely that it includes much contribution from the next product cycle. That means Adobe is expecting 17.5% earnings growth this year without new product launches. I'm impressed.

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At the time of publication, Trent was long Adobe, although positions may change at any time.

William A. Trent, CFA, is a freelance equity analyst based in the New York metro area. He has been an equity analyst since 1996 and is co-author of Understanding and Evaluating Prospectuses, Offering Documents, and Proxy Statements. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Trent appreciates your feedback; click here to send him an email.