Red Hat Inc (RHT), Adobe Systems Incorporated (ADBE): A Great Play on Cloud-Based Software

Adobe Systems Incorporated (NASDAQ:ADBE) is well-known for its software programs designed for creative applications, such as Photoshop, Acrobat, and Creative Suite. Although Adobe Systems Incorporated (NASDAQ:ADBE) is growing at a respectable rate, and is projected to average 10% annual earnings growth going forward, the current valuation of about 30 times earnings is simply not justified. Adobe Systems Incorporated (NASDAQ:ADBE) would need to drop by about 30%, or put up stellar numbers in their next quarterly report to get me to even consider the company as a long-term investment.

Microsoft, on the other hand, is a very good value, even after its recent gains. In addition to being the world’s largest software producer with its Windows operating system and Office productivity software, the company generates substantial income from internet advertising (Bing) as well as through sales of their Xbox video game consoles and recently, their tablet PCs.

Microsoft trades at just 18 times TTM earnings, which is very low considering the following two points. First, the consensus calls for earnings growth of 8.7% and 8.0% in the next two years, which I think is actually a bit conservative due to low expectations for their tablets and new software versions. Second, Microsoft is one of the most cash-rich companies in the market, with about $51.5 billion in net cash, or 18% of their entire market cap. Combined with a healthy 2.7% yield and Microsoft is looking pretty solid right now.

Conclusion

If you want rock-solid stability, good yield, and relatively predictable and stable growth, buy Microsoft. There is absolutely nothing wrong with going this route. If, on the other hand, you have a bit more risk tolerance and want to get in early on what could be the “next big thing” in computing (cloud computing), Red Hat is as good a way as any to play it.

The article A Great Play on Cloud-Based Software originally appeared on Fool.com.

Matthew Frankel has no position in any stocks mentioned. The Motley Fool recommends Adobe Systems (NASDAQ:ADBE). The Motley Fool owns shares of Microsoft. Matthew is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.

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