Is It Too Late to Buy Adobe Stock?

Adobe (ADBE -0.94%) posted an impressive earnings report on June 15. For the second quarter of fiscal 2023, which ended on June 2, the cloud software provider's revenue rose 10% year over year (13% in constant currency terms) to $4.82 billion and exceeded analysts' estimates by $50 million. Its adjusted EPS grew 17% to $3.91 and also cleared the consensus forecast by $0.17.

For the full year, Adobe expects its revenue to rise 9.3%-9.9% as its adjusted EPS grows 14.2%-14.9%. Both of those estimates were raised from its prior outlook for 8.5%-9.6% revenue growth and 11.6%-13.8% adjusted EPS growth.

Image source: Getty Images.

That beat-and-raise quarter brought back the bulls and drove Adobe's stock to a new 52-week high. But is it too late to invest in that high-flying stock after its near-50% rally this year? Let's take a fresh look at its business to decide.

Adobe's growth rates are stabilizing

During the second quarter, Adobe generated 73% of its revenue from its Digital Media segment, which houses its Creative Cloud (Photoshop, Illustrator, Premiere Pro, and other design applications) and Document Cloud (Acrobat, Sign, and other document services). Another 25% came from its digital experience segment, which provides its enterprise-oriented marketing, e-commerce, and analytics services.

Both businesses cooled off in 2022 as the macro headwinds forced companies to rein in their spending. However, the stickiness of Adobe's cloud-based subscriptions enabled it to keep generating double-digit revenue growth over the past year.

Data source: Adobe. Constant currency terms. YOY = Year-over-year.

Adobe's full-year outlook for 9%-10% revenue growth is stable, but it would still represent a slowdown from its 12% growth in fiscal 2022 and 23% growth in fiscal 2021. It also implies its year-over-year revenue growth will cool off in the second half of the year as its digital experience segment struggles with delayed projects and tighter enterprise spending.

Adobe's guidance also doesn't include any potential gains from its planned $20 billion acquisition of the design software start-up Figma, which it plans to close by the end of this year. Figma more than doubled its annual recurring revenue (ARR) for the second straight year to $400 million in 2022, so it could significantly boost Adobe's Creative Cloud revenue.

Adobe's recent launch of Firefly -- a generative AI service that enables its Creative Cloud users to create images, videos, and digital models with simple text prompts -- could also expand the segment's total addressable market beyond digital media professionals while giving it a firm foothold in the growing AI market.

Adobe's operating margins should expand in the second half

Adobe's gross margin still expanded 20 basis points year over year to 88% in the first half of fiscal 2023, which suggests its industry-standard media tools and sticky cloud subscriptions still give it plenty of pricing power against its potential competitors. However, its operating margin still shrank 210 basis points to 33.9% in the first half as the persistent macro and currency headwinds boosted its operating expenses.

During the conference call, CFO Dan Durn addressed those concerns by declaring Adobe would experience a "solid operating margin expansion" on a year-over-year basis in the second half of fiscal 2023 as some of those headwinds dissipate. That's why Adobe raised both its revenue and adjusted EPS estimates for the full year.

Adobe is generating plenty of cash and buying back a lot of shares

Adobe's operating cash flow rose 5% year over year to $2.14 billion in the second quarter, and it bought back 2.7 million shares. It still has $4.15 billion remaining in its current $15 billion buyback plan, which expires at the end of fiscal 2024.

But at $500, Adobe's stock isn't cheap at 32 times this year's adjusted EPS. Its insiders also sold about 35 times as many shares as they bought over the past 12 months. For reference, Salesforce, which competes against Adobe's digital experience division, is growing at a similar rate but trades at just 28 times forward earnings.

Yet Adobe's buybacks, which reduced its share count by 4% over the past three years, suggest it isn't overvalued. Its stable growth, sticky ecosystem, future gains from Figma, and new generative AI features could all justify its higher valuation.

So is it too late to buy Adobe?

I don't think it's too late to buy Adobe as a long-term play on the cloud and AI markets. But if you're expecting Adobe to rally another 50% through the end of 2023, you'll likely be disappointed because its valuations could cap its near-term gains.