3 Reasons to Buy Adobe, and 3 Reasons to Sell

Adobe (ADBE 0.87%) posted its latest earnings report on Sept. 14. For the third quarter, which ended on Sept. 1, the creative software giant's revenue rose 10% year over year (13% in constant currency) to $4.89 billion and topped analysts' estimates by $20 million. Adjusted earnings per share (EPS) grew 20% to $4.09 and cleared the consensus forecast by $0.11.

Adobe's stock dipped after that report, but it's still sitting on a year-to-date gain of 64%. Let's review three reasons to buy Adobe -- as well as three reasons to sell it -- to see if it's worth buying at these levels.

Image source: Getty Images.

The three reasons to buy Adobe

The bulls still love Adobe for three reasons: Its sales are stabilizing after recent declines, its adjusted operating margins are expanding, and it's a promising play on artificial intelligence (AI).

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

Like many other cloud software companies, Adobe struggled with slower growth over the past year as headwinds drove its clients to rein in their spending. But over the past three quarters, its sales growth stabilized in constant currency terms.

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

For the fourth quarter, Adobe expects its revenue to rise 10% to 11% year over year on a reported basis. Assuming the foreign exchange rates hold steady, that would likely translate to about 13% year-over-year growth again on a constant currency basis.

It also suggests its full-year revenue will rise about 13% on a constant currency basis, which would only represent a slight slowdown from its 15% growth on the same basis in fiscal 2022.

As Adobe's top-line growth stabilized, it optimized its spending but didn't do any mass layoffs. As a result, its adjusted operating margin expanded 210 basis points year over year and 100 basis points sequentially to 46.2% in the third quarter. For the full year, it expects its adjusted operating margin to rise 40 basis points to 45.5%.

Adobe expects its adjusted EPS to rise 14% to 15% year over year in the fourth quarter, which implies its adjusted EPS will grow roughly 16% for the full year. That would represent an acceleration from its 10% adjusted EPS growth in fiscal 2022.

Adobe's growth rates are stable because many of its services are considered industry-standard tools for media professionals, and it keeps those customers locked in with sticky cloud-based subscriptions.

Its rollout of its new Firefly generative AI tools -- which enable the creation of AI-generated content across its Creative Cloud and the acceleration of digital workflows on its enterprise-oriented services -- should further increase that stickiness and make it a balanced play on the booming AI market.

The three reasons to sell Adobe

The bears will acknowledge those strengths but warn you that Adobe's Figma acquisition isn't a done deal yet, its valuations are high, and its insiders are dumping a lot of shares.

By the end of this year, Adobe plans to spend $20 billion to acquire the design start-up Figma, which more than doubled its annual recurring revenue (ARR) for the second straight year to $400 million in 2022. That acquisition would eliminate Adobe XD's top competitor in the markets for software user interfaces (UI) and user experiences (UX) while giving its Creative Cloud another major growth engine.

But that acquisition still faces regulatory challenges in the U.S., U.K, and Europe as its critics say the takeover will enable Adobe to monopolize the UI/UX market. Adobe will need to pay Figma $1 billion if it walks away from the deal.

In addition to that uncertain outcome, Adobe's stock looks a bit pricey at 31 times forward earnings. Its rival Salesforce (CRM 0.42%), which is expected to grow its adjusted EPS by 54% in its current fiscal year, trades at just 28 times forward earnings. Therefore, quite a bit of AI hype still seems to be baked into Adobe's valuations.

As the stock rallied nearly 50% over the past 12 months, its insiders sold 45 times as many shares as they bought. That chilly insider sentiment suggests that it could be due for a pullback when the buying frenzy in AI stocks finally ends.

Which argument makes more sense?

Adobe's stock isn't cheap, but it's also an evergreen tech giant that is growing impressively as it diversifies its ecosystem with new AI features. The stock's near-term upside potential might be limited at these levels, but I believe it's still a great long-term cloud and AI play for patient investors.