Adobe Stock Falls: Time to Buy?

Adobe (ADBE 3.60%) has been a powerful software company for a long time. It was one of the first to move to a subscription model, a practice that almost every software company has adopted. Now, the company is at the crossroads of another monumental shift: generative artificial intelligence (AI).

The stock recently fell 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 heavily used

Adobe products are the industry standard in graphic design. Its design suite has several programs tailored to specific applications and can be purchased for a monthly fee.

However, with the rise of several generative AI models that offer free image generation, many investors are concerned that Adobe could be in trouble. After all, it’s hard to compete with free. But this is a short-sighted view. Although some of these services may be free, eventually they will have to charge a fee. The power and data centers these services run on aren’t free, and while they may now be able to get away with ad revenue from their site, that may not always be the case.

When that happens, companies will likely continue to rely on Adobe’s image-generating AI model, Firefly. Management is optimistic about its Firefly AI model and has begun integrating it into its various software programs. They’ve also been massively used: 12 billion images have been generated with the model in its software suite.

Adobe is clearly one of the leaders in the image generation AI space, not one that is being disrupted. But why did the stock drop?

Q3 results were solid for Adobe

In the third quarter of fiscal 2024 (ended August 30), Adobe posted revenue of $5.41 billion, up 11% year over year. That number beat the $5.33-$5.38 billion range management projected for the quarter, which is a great sign.

That story also holds true for Adobe’s earnings per share (EPS) figure, as it posted earnings of $3.76 versus a range of $3.45 to $3.50. Stocks usually don’t fall if the narrative surrounding the business is on track and a company is posting top- and bottom-line earnings beats.

The problem investors found with Adobe’s results was its forward-looking outlook, which missed Wall Street expectations. Adobe projected $5.5 billion to $5.55 billion for Q4, while Wall Street was looking for about $5.61 billion. That would indicate growth of 8.9% to 9.9% year-over-year, which may be a bit slow for some investors. However, Adobe’s management has a track record of slightly under-projected growth, so it can beat its forecasts every quarter. If management did that here, then they could hit the range that Wall Street wants.

So it looks like the selloff happened for some silly reason, but is the stock in a buy range?

The stock is slightly cheaper than its historical averages

With a mature company like Adobe, it’s smart to look at a valuation metric that takes earnings into account, such as the price-to-earnings (P/E) ratio or forward P/E ratio.

ADBE Data ON Report by YCharts

While Adobe isn’t cheap in the general sense of these valuation metrics, it’s slightly below its historical averages on both measures. As a result, I think Adobe is a stock that investors can buy with confidence here, as it has enough growth to continue to outperform S&P 500 on a consistent basis.