Is It Too Late to Buy Adobe Stock?

Adobe's (ADBE 0.87%) stock has surged more than 80% this year and is currently hovering near its 52-week high. Most of that rally was driven by the market's enthusiasm regarding the cloud software giant's new artificial intelligence (AI) tools, its stabilizing sales growth, and expanding operating margins.

But is it too late to hop aboard the bullish bandwagon and buy Adobe's stock? Let's review its growth rates, valuations, and longer-term catalysts to decide.

Image source: Getty Images.

Its cyclical slowdown could end soon

In the third quarter of fiscal 2023 (which ended on Sept. 1), Adobe generated 73% of its revenue from its Digital Media unit, which houses its Creative Cloud (Photoshop, Premiere Pro, Illustrator, and other digital media applications) and Document Cloud (Acrobat, Sign, and other document services). Another 25% of its revenue came from its Digital Experience unit, which handles its enterprise-oriented marketing, commerce, and analytics services.

The macro headwinds throttled the growth of both businesses over the past year as individuals and companies reined in their software spending. But over the first three quarters of fiscal 2023, its revenue growth stabilized in constant currency terms.

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

It expects that streak to continue with 13% constant currency revenue growth in Q4. That forecast implies its full-year revenue will also rise 13% on the same basis compared to its 15% constant currency growth in fiscal 2022.

That stabilization can be attributed to the stickiness of its cloud-based subscriptions and the industry-standard reputation of its digital media tools. Its users can't easily break free of those subscriptions or swap to other services.

Unlike many other tech giants, Adobe hasn't executed any mass layoffs to cut costs. Instead, it merely optimized its spending across the board and expects to expand its adjusted operating margin from 45.1% in fiscal 2022 to 45.5% in fiscal 2023. It expects its adjusted earnings per share (EPS) to rise 16% for the full year, compared to its 10% growth in fiscal 2022.

But is Adobe's stock getting overvalued?

Those growth rates look promising. But at $613, Adobe also looks a bit pricey at 34 times forward earnings and 17 times next year's sales. For reference, its cloud-based design competitor Autodesk trades at 27 times forward earnings and 8 times next year's sales. Its enterprise cloud software rival Salesforce trades at 24 times forward earnings and 6 times next year's sales.

Adobe's stock trades at a higher valuation for three reasons. First, it's growing at a slightly faster rate than Autodesk and Salesforce. Second, its Digital Media unit could expand significantly if it closes its planned acquisition of Figma -- its closest competitor in the software user interface (UI) and user experience (UX) markets -- for $20 billion.

Last but not least, Adobe's recent rollout of its Firefly generative AI tools caused the market to revalue it as an AI stock instead of a cloud one. These tools are enabling its Creative Cloud users to create more AI-generated content while accelerating a wide range of digital workflows across its enterprise-oriented cloud services. They aren't generating significant revenues on their own yet, but they could significantly increase the stickiness of its cloud ecosystem.

Those strengths seem to justify its higher valuation. However, Adobe's takeover of Figma still needs to clear a lot of regulatory hurdles, and the AI bubble could eventually pop. Adobe will need to pay Figma $1 billion if the deal collapses, and the recent drama at OpenAI reveals just how volatile, unpredictable, and fragile the AI market can be.

Therefore, one wrong move could cause Adobe to quickly lose its premium valuation. That might be why Adobe's insiders only bought 40 shares over the past 12 months while selling 182,386 shares. They also didn't buy a single share over the past three months even as its stock rallied more than 20% and hit fresh 52-week highs.

Is it too late to buy Adobe's stock?

Adobe still has a bright future. It successfully transformed its desktop software into cloud-based services over the past decade, and it could upgrade those services into AI-powered tools over the next few years. However, its upside potential over the next few quarters could be limited by its valuations, and unexpected challenges for the Figma deal or the broader generative AI market could drive away the bulls.

Therefore, I think it's a bit too late to buy Adobe as a short-term play for the next few quarters. But as a long-term play for the next few years, it could continue to climb higher and outperform the market as the cloud and AI markets continue to expand. Simply put, investors who can ride out the volatility should still accumulate more shares of this resilient tech giant.