Adobe Reports Growth From New AI Services, but Is the Stock Really a Buy Now?

Share prices of creative software and document management giant Adobe (ADBE 0.87%) are making a dramatic comeback. Though shares still trade off nearly 30% from all-time highs that were notched during the pandemic boom, Adobe is getting a positive lift from the artificial intelligence (AI) hype cycle. The stock is up nearly 50% in the last six months.  

Despite all the excitement around new AI tools (thanks to Nvidia's work on chips as much as on Adobe's own software development), Adobe is still turning in sluggish financial reports. Is the stock really a buy now?  

Adobe offers a solid financial update, but how worthy is the hype?

For all of the wild predictions about generative AI growth (kicked off by the viral ChatGPT service) and how it will transform the world, one might expect Adobe and its new suite of AI-powered tools (called Firefly) to equate to a rapid ramp-up in revenue growth. After all, Nvidia reported expectations its data center chip revenue will nearly double from the most recent quarter to the next because of AI.

But Adobe is an Nvidia customer and needs to purchase lots of AI-enabling hardware and develop new services to keep pace with all of its software peers that are doing the same. Nvidia's explosive growth will not be the same for Adobe. For now, software customers still behaved cautiously this year as they manage a slowing economy and perhaps even a 2023 recession. 

This translated to lower growth for Adobe during its second-quarter fiscal 2023 (the three months ended at the beginning of June 2023) and for the remainder of the fiscal year -- at least slower growth than in times past.

Data source: Adobe. YOY = year over year.

The good news here is that, although revenue is slowing down, Adobe's earnings-per-share (EPS) growth is showing signs of life again. The company also repurchased about $1 billion worth of stock in the last quarter as it continues to return excess cash to shareholders. 

Data by YCharts.

Is Adobe the best AI software stock to buy now?

After the recent surge, Adobe is now valued at 47 times trailing-12-month EPS (or 31 times trailing-12-month free cash flow). That valuation drops to 28 times EPS based on Wall Street analysts' EPS expectations for next year.  Without a doubt, it's a premium price that anticipates plenty of Adobe growth -- from AI and "old" non-AI creative software alike -- for years to come. Adobe has a track record of delivering. 

I'll admit, I sold my longtime Adobe stake earlier this year to consolidate my holdings. I've been investing in semiconductor stocks instead, which I think will be the biggest beneficiaries of the AI movement in the coming five years. 

However, one key Adobe competitor I ramped up my holding in was Salesforce, which had a slew of AI software announcements of its own. For similar revenue growth as Adobe, but rapidly improving profit margins, Salesforce still looks like the better deal to me at 30 times trailing-12-month free cash flow and 23 times next year's expected EPS.  

I'll stop short of saying Adobe stock's recent rise is unsustainable. The AI hype isn't a bubble. There are real business benefits fueling growth and higher profits. For investors looking for a great business to own for the long haul, Adobe is a great choice. But I continue to see better values out there right now.