Virtually all investors aim to identify stocks that offer growth potential while being reasonably priced relative to their fundamentals. This approach is often associated with legendary investor Peter Lynch, who advocated for a balanced approach to investing.
To characterize a company as "growing," I generally have two criteria. First, revenues must grow faster than nominal GDP growth (non-inflation adjusted), or in the rare case that real GDP shrinks, revenue growth must outpace inflation. If revenues aren't growing as fast as the economy or inflation, then it is shrinking in real terms. Second, I look for net income or adjusted earnings per share growth to exceed that of the S & P 500 comfortably.
The S & P has delivered remarkable long-term earnings growth, doubling in the past 10 years, a compound annual growth rate (CAGR) of nearly 8%. Most companies don't have the inherent benefits of diversification that an index has or the expected lifespan, so a decent track record of greater than 10% annual earnings growth is probably a suitable starting point.
Adobe (ADBE) -- known for brands such as Acrobat and Photoshop and their creative cloud offering -- is one of the largest diversified software companies. The company reports after the bell next Wednesday. Over the past 10 years, revenues have increased nearly fivefold, and earnings have risen from just under $750 million in fiscal 2014 to almost $6.3 billion over the last four reported quarters.
The Street consensus is that the company will report more than $8.2 billion in adjusted net income next week when they report fiscal 2024 results.
ADBE remains at the epicenter of digital transformation with a comprehensive suite of products.
AI play
The challenge is that technology evolves rapidly, meaning new competitors are entering the scene. AI is the catchphrase, as it is in almost every industry these days. Adobe's entrant in GenAI (Generative Artificial Intelligence), a system designed to generate new content based on prompts or inputs, is "Firefly."
If Adobe can monetize Firefly and sustain its growth, it is reasonably valued at 26 times forward earnings estimates.
The trade
With these two contradictory considerations, a trade positioned to profit on a move higher but still achieve satisfactory outcomes if recent weakness persists through earnings makes sense—such as a "strangle swap," which combines downside bearish calendar put spread and upside bullish calendar call spread.
- Sell ADBE Dec. 20 $480 put
- Buy ADBE March 21 $480 put
- Sell ADBE Dec. 20 $600 call
- Buy ADBE March 21 $600 call
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