By Jacob Sonenshine

The final weeks of first-quarter earnings season offer opportunities to find promising stocks in an increasingly complex market.

A look at how the profit-reporting season has gone so far, and how markets have been performing, explains why. Earnings season began with valuations so high, following 2023 and 2024's double-digit gains in the S&P 500, that even strong results couldn't push stocks much higher. Even stocks of companies whose earnings exceeded expectations weren't consistently performing well.

Then the entire market hit a speed bump as President Donald Trump's plans for widespread tariffs raised concern about profit margins and U.S. consumer demand.

The emergence of DeepSeek, a Chinese artificial-intelligence start-up, was another setback. It raised concern about U.S. leadership in AI, and therefore spending on chips, data centers, and power-generation capacity. U.S. companies are unaffected so far, and Nvidia CEO Jensen Huang has pushed back against those concerns, but the market will continue to monitor the issue over the next several earnings reporting seasons.

The S&P 500 is currently down almost 3% from a record close hit this month.

The market drop has left investors scouring for opportunities to pick up bargains, especially ahead of earnings releases. The hunt isn't simple -- even though the S&P 500 has dipped, aggregate earnings expectations for member companies have fallen too, leaving the index near its priciest level in the past four years, at 22 times forecast profits for the coming 12 months.

But while many stocks remain stubbornly expensive, there are many dotted around the market that have become cheaper. Some still haven't reported earnings, creating the potential for the stocks to pop if the results are better than expected.

That is why 22V Research's Dennis DeBusschere created a stock screen looking for "high earnings quality names," or companies whose results are likely to beat estimates. That is critical for post-earnings gains in the current expensive market.

To identify the stocks most likely to rise post-earning, Barron's took a look at companies that DeBusschere identified whose stocks have fallen by more than 2% from record highs. The names include Darden Restaurants, Ulta Beauty, Best Buy, Cintas, and Oracle. All of them have turned in higher-than-expected earnings in the majority of the past 20 quarters.

Another is Adobe, a $192 billion company whose stock has fallen 33% from its record high in 2021. Concern that AI offerings from the provider of graphics and design software aren't adding much in the way of additional sales have left the stock trading at a lower price/earnings ratio. The stock is down 5% from its 2025 high, hit this month, as the overall market has fallen.

All that represents an opportunity, partly because Adobe has beaten earnings estimates in all of the past 20 quarters, according to FactSet. It reports its fourth- quarter results for calendar 2024 on March 12.

Analysts are looking for sales of $5.66 billion, representing 9.3% growth from a year earlier. Profit margins may not rise much because management may have boosted its spending on marketing and research and development. But stock buybacks, funded by cash flow and over $3 billion of net cash on hand, could lift per-share earnings. The consensus call among analysts tracked by FactSet is for a gain of 11% to $4.97.

The recent growth has come as Adobe has built up its subscriber base for its software, and a bigger increase in sales and profit than expected could lift the stock. But the key to larger gains is management's commentary about new AI products and the financial outlook for this year.

Investors want to hear that Adobe can maintain its growth by lifting subscription prices specifically because of AI. "We see ramping Generative AI monetization in second half [2025] as a key catalyst for the shares," Morgan Stanley analyst Keith Weiss wrote in a research note last week.

While Adobe has tiered pricing -- the "pro" version costs more -- a "premium" tier is on the way, he said.

It would make sense for customers to pay up if Adobe's photo capabilities, documentation and entire suite of products allows them to produce graphics and materials faster, and perhaps with fewer staff. Weiss says the Firefly Video product is improving, as management looks to edge out AI competitors such as Microsoft's Sora. It can now translate text and images into videos, among several other new features.

Evidence that Adobe is cashing in on AI would boost the market's confidence that its can sustain its growth, ultimately curb its investments, bump margins higher, and increase EPS even faster.

Take a chance on Adobe -- or any of these other stocks.

Write to Jacob Sonenshine at jacob.sonenshine@barrons.com

This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.

(END) Dow Jones Newswires

February 25, 2025 15:27 ET (20:27 GMT)

Copyright (c) 2025 Dow Jones & Company, Inc.