Adobe (NASDAQ: ADBE) faced a tumultuous Friday as its stock saw a significant downturn following the announcement of record revenue juxtaposed with tepid Q2 fiscal 2024 guidance. The past few months have witnessed a wave of success for the broader market, particularly within the realm of artificial intelligence (AI) driven growth equities. But Adobe’s recent performance has sparked questions about the future trajectory of AI stocks.
For a thorough examination, let’s delve into Adobe’s financial results and insights provided by company management to discern whether the current outlook signals a broader concern for the AI investment landscape or if Adobe’s challenges are largely confined to its internal dynamics.
Image source: Getty Images.
The AI Integration at Adobe
Adobe has always had a stake in AI; it’s just that the current narrative has brought AI to the fore. The company’s flagship product, Creative Cloud, encompasses an array of applications enabling creators to engage with various media forms such as text, images, and video. In recent years, Adobe experienced a slowdown in growth, prompting a quest for a catalyst to reignite investor enthusiasm.
In a strategic move on March 21, Adobe unveiled Firefly, an AI tool set to revolutionize workflows across Creative Cloud, Document Cloud, Experience Cloud, and Adobe Express. The introduction of Firefly, coupled with the promise of monetizing AI, propelled Adobe stock to soar over 77% in the previous year.
However, the recent earnings call shed light on a pivotal shift, underscoring the fact that while these new applications hold immense promise, their tangible impact on immediate financial results may be limited. This pivot in momentum is reflected in Adobe’s cautious Q2 fiscal 2024 guidance and its decision to withhold updates on full-year projections, a notable departure from its stance in the Q4 fiscal 2024 earnings call held in December.
The market’s aversion to uncertainty was palpable during the Q&A session, with analysts predominantly fixated on near-term performance metrics and fiscal year 2024 projections, as opposed to focusing on Adobe’s long-term strategic investments and the envisioned outlook for the next three to five years.
The Tangible Impacts of AI on Adobe’s Growth Trajectory
Adobe Firefly users within the Creative Cloud and Adobe Express ecosystems have collectively generated an impressive 6.5 billion assets ranging from images, vectors, designs, to text effects. Noteworthy milestones include a surge in new commercial subscriptions for Creative Cloud and tantalizing hints regarding forthcoming products for Adobe Express, featuring Firefly integration for mobile, Firefly Services, and an AI assistant tailored for Adobe Acrobat.
Within its product portfolio, Adobe continues to double down on innovation, showcasing progress across existing products and mobile platforms while introducing novel offerings like AI-powered Enhance Speech, facilitating automatic video dubbing into the user’s preferred language.
However, it is crucial to approach current quarterly results judiciously, given that Adobe is currently grappling with a one-time $1 billion charge linked to the termination of its acquisition deal with Figma, an arrangement announced back in September 2022. Moreover, the extensive investments in product innovation may yield substantial results only after a few years.
During the earnings call, Adobe emphasized its strategic focus on expanding its user base. The premise lies in bolstering customer acquisition and retention to unlock long-term monetization prospects. Renowned for pioneering the software-as-a-service (SaaS) model, Adobe adheres to its fundamental principles when navigating the realm of AI.
An interesting highlight of the earnings call was Adobe CEO Shantanu Narayen distinguishing between experimental ventures and strategies conducive to revenue generation on its platforms. Adobe is treading carefully to discern which innovations resonate with users, a critical consideration to avoid investing substantial sums in tools that either remain underutilized or fail to justify future price hikes.
One of the primary hurdles facing Adobe pertains to deriving profits from AI. Given its subscription-based business model, the company’s ability to support escalating capital outlays hinges on expanding its customer base and boosting revenue per user. A fitting analogy is Netflix, which must enhance its service’s value proposition through quality content to warrant price increments.
The reassuring aspect for Adobe lies in its clientele predominantly comprising businesses, with a smaller segment represented by students and individual creators. This diversified consumer base diminishes its reliance on consumer spending dynamics. Should customers seamlessly integrate AI-driven tools like Firefly into their workflows, possible price hikes may be absorbed organically. Nevertheless, assuming this as a foregone conclusion would be overly optimistic.
A Thoughtful Buyback Strategy
At the core of Adobe’s investment appeal lies its commitment to consistency. Steady growth fueled by dependable subscription revenues fuels a culture of innovation complemented by an often overlooked capital return program.
Over the past decade, Adobe managed to reduce its outstanding shares by 9.2% despite witnessing a staggering 400% surge in stock-based compensation. The recent announcement of a $25 billion stock repurchase initiative over the next four years underscores Adobe’s commitment to proactively mitigate share count. As of the current market capitalization standing at approximately $227 billion, the arithmetic reveals Adobe’s intent to slash share count by around 11% over the next quadrennium, a rate surpassing the preceding decade’s trend.
The stock buyback initiative serves to spread earnings across a smaller shares corpus, thereby amplifying earnings per share (EPS) and enhancing Adobe’s intrinsic value. This strategic move fortifies EPS, even when the underlying business undergoes subdued organic growth.
Adobe isn’t encountering a growth plateau; in contrast, its organic growth remains robust. Yet, the reluctance to update full-year guidance implicitly suggests that the growth trajectory may not align with erstwhile investor anticipations when Adobe was riding high on a 52-week peak merely six weeks ago.
Tempering Expectations for Future Growth
Adobe’s recent performance doesn’t represent a cautionary tale for AI growth stocks; rather, it presents an opportunity for investors to refocus their lens on the long-term feasibility of AI initiatives. Adobe’s clear monetization strategy for AI positions it as a compelling contender for sustained growth.
Even amidst the recent sell-off, Adobe’s valuation remains robust. It’s prudent not to place excessive emphasis on trailing earnings due to the Figma impairment incident. Analysts’ projections anticipate $20.30 in EPS for fiscal 2025, translating to a price-to-earnings ratio of 24.6. However, this forecast hinges on earnings projection seven quarters down the line.
While Adobe may not scream a compelling buy at present, the market may be underestimating its growth potential. Monitoring Adobe closely or establishing an initial position could be prudent moves. Should Adobe undergo a prolonged downturn, the subsequent valuation would undoubtedly present an irresistible entry point.
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Daniel Foelber has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Adobe and Netflix. The Motley Fool operates under a transparent disclosure policy.
The insights and opinions expressed here convey the author’s perspective and do not necessarily mirror those of Nasdaq, Inc.
