On Wednesday, Adobe Inc.’s (NASDAQ: ADBE) stock price gapped lower after the software maker lowered its guidance for the fourth quarter. However, it bounced back quickly on large volume, establishing a strong support level at $270 in the process. The stock which was down 5% at one stage, ended the day 1.74% lower at $279.72. On Thursday it traded back up to resistance before retreating.

Back in June, when Adobe released second-quarter results, the stock rallied despite conservative guidance. This time around, solid results, and softer guidance resulted in a knee jerk selloff. This seems to reflect a change in the attitude of investors to the sector, rather than to the company itself.

 

Solid Growth Off a High Base

Quarterly revenue of $2.58 billion and GAAP EPS of $1.61 were both comfortably ahead of analyst estimates. Revenue rose 23.6% year on year, while earnings rose 20%. While cost of sales did increase faster than revenue growth, those increases have slowed since peaking at 53% in March.

Guidance for fourth-quarter revenue was lowered to around $2.97 billion, 1.5% below consensus estimates from analysts. This will represent year on year growth of 21%.

 

Best of Breed

While the stock is not exactly cheap, when one considers the valuations of other SaaS stocks, it looks perfectly reasonable.

Adobe should not be lumped together with other high-flying SaaS stocks that report strong revenue growth but struggle to turn a profit. Adobe’s cash flow from operations is running at nearly $1 billion a quarter and the company is actively buying back shares. Operating margins are close to 30% and the company’s return on equity is over 25%.

While the stock is not exactly cheap, when one considers the valuations of other SaaS stocks, it looks perfectly reasonable. It also offers a high-quality alternative to riskier names in the sector.

Besides being a high quality, very profitable company, Adobe is also a leader in a growing market. The digital economy is creating more opportunities for creative professionals around the world. Adobe’s creative suite now offers these professionals over 20 applications under a single license – a proposition that won’t be beaten anytime soon.

In July the company also launched Fresco, a new drawing app designed for tablets like the iPad. This app competes head on with other leading drawing apps like Procreate but allows for seamless integration with the rest of Adobe’s creative suite.

 

The Technical Picture

Wednesday’s low was the lowest the share has traded since early June and was nearly 15% below the all-time high printed in August. The low also tagged the 200-day moving average for the second time this year – the previous occasion in March also resulted in a sharp reversal.

$270 is now a good reference point for investors as the level was tested on heavy volume and held. The stock should remain above that level barring a major market correction. If $270 does break, investors may get a bargain entry closer to the long-term trend line at $250.

In the meantime, resistance is at $284, a break of which may lead to a squeeze back up to the highs at $310.

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