Adobe (NASDAQ: ADBE) has long been a software company stalwart. It was one of the first companies to move to a subscription model, a practice that nearly every software company has since adopted. Now, the company finds itself at the crossroads of another monumental shift: generative artificial intelligence (AI).
The stock recently dropped about 10% after Adobe reported its latest financial results. So, is Adobe losing the generative AI race? Or is something else going on here?
Adobe’s generative AI model is widely used
Adobe products are the industry standard in graphic design. The design suite has multiple programs that are tailored to specific applications and can be purchased for a monthly fee.
However, with the emergence of various generative AI models offering free image generation, many investors are concerned that Adobe could be in trouble. After all, it’s hard to compete with free. But that’s a short-sighted view. While some of these services may be free, they will eventually have to charge a fee. The energy and data centers that run these services aren’t free, and while they may be able to survive on ad revenue from their website now, that may not always be the case.
When this happens, companies will likely still rely on Adobe’s image-generative AI model, Firefly. Management is bullish on the Firefly AI model and has begun integrating it into its various software programs. They’ve also seen massive adoption: 12 billion images have been generated using the model in the software suite.
Adobe is clearly one of the leaders in the image gen AI space, and there is no one that is being disrupted. But why did the stock price drop?
Adobe’s third quarter results were solid
In Q3 of fiscal 2024 (ending August 30), Adobe posted revenue of $5.41 billion, up 11% year over year. That figure beat the $5.33 billion to $5.38 billion that range management had projected for the quarter, which is a good sign.
That story also holds true for Adobe’s earnings per share (EPS), as it posted a profit of $3.76 versus a range of $3.45 to $3.50. Typically, stocks don’t fall when the story surrounding the company is on track and a company is posting both top- and bottom-line gains.
The problem investors had with Adobe’s results was its forward-looking guidance, which missed Wall Street’s expectations. Adobe forecast $5.5 billion to $5.55 billion for Q4, while Wall Street was expecting about $5.61 billion. That would represent 8.9% to 9.9% annual growth, which may seem slow to some investors. However, Adobe’s management has a history of slightly underestimating growth, so it can beat its forecasts every quarter. If management were to do that here, it could achieve the margin Wall Street wants.
It seems like the sell-off happened for a stupid reason. But is the stock in a buying range?
The stock is slightly cheaper than historical averages
For a mature company like Adobe, it’s wise to look at a valuation metric that takes earnings into account, such as the price-earnings (P/E) ratio or the forward P/E ratio.
ADBE PE Ratio data from YCharts
While Adobe isn’t cheap in the broad sense of these valuation metrics, it is slightly below historical averages for both measures. As a result, I think Adobe is a stock that investors can buy with confidence here, as it has enough growth to sustain the S&P 500 on a consistent basis.
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Keithen Drury has positions in Adobe. The Motley Fool has positions in and recommends Adobe. The Motley Fool has a disclosure policy.