When you see an upward trajectory on a stock like Adobe Systems, Inc. (NASDAQ:ADBE), the natural tendency might be to hang on to this high-quality stock for a while longer.
Just take a look at the chart below …
Adobe is widely known for its software offerings, especially its Acrobat Pro software for creating, editing and sending PDF documents.
However, there is much more to this company than just PDFs. Adobe Systems has three business segments: Digital Media, Digital Experience and Publishing. Digital Media encompasses all of Adobe Systems’ popular software, including Photoshop, InDesign, Illustrator, Dreamweaver and Acrobat Pro.
I first added Adobe Systems to my Growth Investor Buy List back in May 2018, ahead of the company’s second-quarter earnings announcement. At that time, Adobe Systems had double-digit forecasted earnings and sales growth.
Over the past three years, the company has not disappointed: It has posted double-digit earnings growth and 10-straight quarterly earnings surprises. For its fourth quarter in fiscal year 2020, Adobe Systems reported 14% year-over-year revenue growth and 22.7% year-over-year earnings growth. Fourth-quarter earnings of $2.81 per share topped analysts’ estimates for $2.66 per share.
The company still has solid forecasted earnings and sales growth. For the first quarter, the analyst community is looking for 22.5% year-over-year earnings growth and 21.6% year-over-year sales growth.
So it may surprise you that I recommended my Growth Investor subscribers sell the stock yesterday for a roughly 99% gain. Why would I recommend selling a stock that looks like it will continue to post such a strong top and bottom line?
The answer goes back to my focus on superior fundamentals. I study data on almost 5,000 stocks every week, focusing on eight “fundamentals.” These various measures of a stock, when taken collectively, can accurately tell you whether a company is doing well.
Here are the eight factors I study when selecting my fundamentally superior stocks:
- Positive Earnings Revisions. I like to see stocks that have had their earnings estimates increased by Wall Street analysts. This usually tips us off to a stock that’s about to “beat earnings.”
- Positive Earnings Surprises. Speaking of beating earnings, I also look to see if a stock has been able to beat its earnings estimates, and by how much. This is an important number to watch, because it often tells me about a stock that Wall Street isn’t paying much attention to or doesn’t yet “get.”
- Increasing Sales. I also like to see a company that can consistently grow its sales over time. Why? Because it’s one number that is hard to fake. My background is in accounting, and I’ve always made sure to steer away from companies that use questionable accounting practices. Sales growth is a solid indicator.
- Expanding Operating Margins. This simply tells me if earnings are growing faster than sales. A company that’s able to expand its operating margins is usually a company that has a dominant position — such as a monopoly — in its industry. This company can raise prices without seeing a drop-off in sales. And that’s a nice place to be.
- Free Cash Flow. This tells me how much money a company has left over after paying the costs of its business. A strong cash flow is important because it allows a company to invest more resources in growing its business.
- Earnings Growth. This is the heart of all good financial analysis. As long as any company is able to grow its earnings consistently, its stock will do well.
- Positive Earnings Momentum. It’s not enough to see a company’s earnings grow — I also want to see it growing rapidly.
- Return on Equity, or ROE. This is the gold standard. ROE tells me how efficiently a company is managing its resources. I can’t interview every senior manager at a company, so I like to think of ROE as a report card for management.
To get a good sense of how any individual stock is doing with regard to the fundamental factors I track, you can use my Portfolio Grader. And here’s what the latest report looks like for Adobe …
As you can see, the stock has a Fundamental Grade of “B,” as well as solid Sales and Earnings Growth scores of “B,” and “A,” respectively.
But I’m concerned with the overall drop off institutional buying pressure, as evidenced by its “D” Quantitative rating and overall D-rating in Portfolio Grader. The Quantitative Grade rating measures the buying pressure underneath a stock. If a stock receives an A- or B-rating, there is strong buying pressure supporting the stock. And the more relentless the buying pressure, the safer the stock. The reality is that persistent buying pressure reduces volatility.
You can think of buying pressure as “following the money.” It signals that money is flooding into a stock and creating more momentum under a stock. So, buying pressure is vital to a stock’s success.
Adobe has also seen a significant drop off in institutional buying pressure and its Quantitative Grade slipped to a D-rating over the weekend. It’s why I recommended my subscribers take advantage of yesterday’s market strength to book a high double-digit gain.
The reality is buying pressure has started to ebb in some big flagship stocks and a leadership change is now underway in the stock market. As a result, the “Alpha” that I calculate in Portfolio Grader is starting to diminish and Quantitative Grades are falling — and that has led me to exit perfectly good, high-quality stocks in recent weeks.
The bottom line is that I let the numbers decide when I choose to buy or sell a stock, not emotions or nostalgia or hope for ongoing performance. Investors who let emotions be their guide can end up holding stocks that will only fail them in the long term. Just because you love a stock doesn’t mean it loves you back.
Note: The Editor hereby discloses that as of the date of this email, the Editor, directly or indirectly, owned the following securities that are the subject of the commentary, analysis, opinions, advice, or recommendations in, or which are otherwise mentioned in, the essay set forth below:
Adobe Systems, Inc. (ADBE)
Louis Navellier had an unconventional start, as a grad student who accidentally built a market-beating stock system — with returns rivaling even Warren Buffett. In his latest feat, Louis discovered the “Master Key” to profiting from the biggest tech revolution of this (or any) generation.
View more information: https://investorplace.com/2021/03/why-louis-navellier-sold-adobe-stock-adbe/