Buy These Beaten Down Shares and Then Watch Them Soar
So many stocks are having a great year. Oil refiner Sunoco (NYSE: SUN), for example, has shot up more than +47%. Southern Copper (NYSE: SCCO) has spiked +38% and its competitor Freeport-McMoRan Copper & Gold (NYSE: FCX) has gained about +27%. Many broad indexes are looking good, too, like the Russell 2000, which has risen +16%, and the S&P 500, up almost +11%.
Yet I’m going to suggest you buy a stock that’s been doing just the opposite. It’s down almost -20% this year, -23% off its one-year high and -39% shy of its five-year peak. With shares of so many other companies posting big gains, why should you bother considering this firm?
Investors have bid down the company’s stock over concern about reduced demand for one of its key products, which accounts for more than half its sales. But I believe the setback is short-lived and the stock will soon be delivering well above-average returns. From its current price of about $29 a share, it could return an average of +17% to +27% a year for the next few years or more. In absolute terms, it should rise by +90% to +150% from now through 2015.
For one thing, so many of us rely on this firm even if we do take it for granted. Its software loads every time we boot up, and most of us have used that software to create, print or send files. The company has long been entrenched in the market for software used to produce content for the Internet, TV and print media, and it’s expanding into new high-growth areas.
I’m referring to Adobe Systems (Nasdaq: ADBE). Investors have been punishing its stock because of slipping sales for its flagship Creative Suite (CS) software that artists, desktop publishers and others use for design and illustration. The latest version, CS5, drove a +37% increase in fiscal third quarter sales to nearly $550 million at Adobe’s Creative Solutions division. Adobe expects the division’s revenue to be roughly the same in the fourth quarter, again with CS5 as the main driver.
The problem: At current levels, Creative Solutions’ revenue appears to be tailing off from its $571 million peak in the fourth quarter of 2007, when CS3 generated the lion’s share. The concern is that, from here on out, it’ll be progressively more difficult to sell each new upgrade, causing sales of that crucial product line to continue eroding — hence this year’s poor stock performance.
It’s a valid concern, but management isn’t just going to sit back and watch it happen. They’re already aggressively pursuing other avenues and recently made a key acquisition, announcing on October 29th that Adobe bought Swiss software maker Day Software Holding for $250 million. Day’s CQ5 online marketing and communications platform should be a profitable addition to the stalwarts that make up Adobe’s CS package, such as Photoshop, Acrobat, Illustrator and Flash Player.
Also, on September 15th of last year, Adobe began moving into the rapidly growing field of web analytics — the measurement of website traffic and activity — by acquiring Omniture, a firm specializing in that area. Omniture already accounts for about 10% of Adobe’s total revenue (which should hit about $3.7 billion by year’s end).
Established products still have plenty of earning potential, too, provided Adobe continues to provide high-quality updates. Flash Player, for example, is the foundation for YouTube and many other video websites. Acrobat and Flash Player combined are on more than 600 million PCs and other computers. And once people have learned how to use them, they’re not usually that quick to switch to competing software.
I therefore agree with projections for revenue growth at Adobe of +10% per year and earnings growth of +12% to +14% annually, on average, through 2015. That’s with all the potential headwinds like competition from rivals such as Microsoft (Nasdaq: MSFT), any issues with the ongoing integration of Omniture, and progressively greater difficulty selling CS upgrades.
Action to Take –> If you’ve got cash and a spot in your portfolio for a high-quality, established software firm, buy Adobe for its market-beating return potential. Importantly, main rival Microsoft probably won’t be able to compete like it could if it didn’t constantly have to fend off antitrust complaints from competitors and government officials.
Also, I haven’t heard of any notable problems with the integration of Omniture other than its CEO resigning last July, less than a year after Adobe acquired the company. Overall, the integration seems to be going smoothly and hasn’t saddled Adobe with any financial burdens it can’t handle.