Artificial intelligence (AI) unlocked a new growth gear in the tech sector. While the spotlight often shines on chipmakers like Nvidia or behemoths like Microsoft, software-as-a-service (SaaS) companies are also leveraging AI to improve their offerings.
One industry-leading SaaS company is Adobe (ADBE -0.34%), which normally wouldn't be an under-the-radar AI play. The stock's poor performance would indicate the company is behind the curve when, in reality, it is rapidly innovating at arguably its fastest pace ever.
Here's why Adobe is out of favor and why it is a growth stock worth buying now.
Image source: Getty Images.
Adobe's numbers have failed to impress
Out of all the tech stocks with over $200 billion in market cap, Adobe is the worst-performing year to date.
Over the last year, it is up just shy of 27% -- barely keeping pace with the S&P 500. Part of the problem is a lack of earnings growth. Trailing diluted 12-month earnings per share are lower today than they were three years ago. Adobe is still in the early innings of many AI-related improvements to its services suite. Its financials have yet to reflect this potential growth. The lag factor is evident in its expenses versus sales and operating income.
ADBE Research and Development Expense (TTM) data by YCharts
Adobe's research and development and operating expenses are up big and are eating away at its near-term profit. On Adobe's first-quarter fiscal 2024 earnings call, analysts were keen on reading into the quarterly figures and soft guidance arguably more than Adobe's multidecade runway with AI. For Adobe stock to regain favor, it seems the company will need to show all of these investments will pay off with bottom-line improvements.
Takeaways from Adobe Summit 2024
In late March, the company hosted Adobe Summit 2024, its annual digital experience conference. This year's focus was on AI.
The conference came just a couple of weeks after Adobe's disappointing earnings call and report, which included weak guidance as the company struggles to monetize AI in the short term. With the stock at a six-month low, the conference was a crucial opportunity to provide valuable insight into the company's projects, innovations, and widespread use cases for leveraging AI across its services. However, it also served as a reminder that Adobe has spent over a decade using AI to harness data, build models, and improve applications. The next leg of innovation is thanks to strides in computing power and cloud infrastructure, which make gaining insights far easier than when IT teams relied on disparate data systems.
For example, Adobe's AI Assistant for Acrobat and Reader allows users to extract more value from documents. It's basically evolving the "find function" into generative AI that can interact and summarize documents and even answer questions. The AI Assistant expedites the research process and helps speed up tasks.
FireFly Services automates content generation tasks to speed up workflows and improve output. AI helps with text-to-image generation and editing functions like auto-straighten, auto-tone, removing backgrounds, and cropping.
Adobe is leveraging AI in its enterprise solutions as well. Applications built on the Adobe Experience Platform can take data from multiple sources and make it more useful for marketers, product managers, data scientists, and more. It's one way to bridge the gap between creative teams and marketing teams.
Adobe announced an AI Assistant for the Adobe Experience Platform to help better access, manage, and gain insights from customer data. The company's goal is to deliver personalization at scale using generative AI through apps and interfaces, models, and data.
As Anil Chakravarthy, Adobe's president of Digital Experience, said during the keynote presentation, "We believe we are in a unique position to help you move Gen AI from a shiny new toy to technology that you can confidently put into production and from which you can get real business value." That encapsulates the central message of the conference, which was the practical application of AI across the Adobe software suite.
Buzzwords aside, the through line is that Adobe has a lot of use cases for generative AI. That's a good start, but Adobe still needs these improvements to be well-received by developers to drive pricing power, sales growth, and margin expansion.
Adobe is a good value
Diluted earnings per share (EPS) was $11.82 on a generally accepted accounting principles (GAAP) basis but $16.07 on a non-GAAP basis. However, analyst consensus estimates call for $18.03 in fiscal 2024 EPS and $20.37 in fiscal 2025 EPS. Fiscal 2024 will mark the 12-month period ending Dec. 1, 2024. At a price per share around $485 and based on that $18.03 EPS estimate, Adobe would have a price-to-earnings ratio of 26.9.
That's a compelling valuation, considering Adobe is still spending a lot on product development and figuring out the best ways to monetize AI with its SaaS model.
It's still too early to tell what kind of earnings growth Adobe will average for the next three to five years. However, given its market position and high-margin business model, the valuation looks like a steal if it can deliver.
Play the long game with Adobe
Adobe is a good example of understanding the differences between Wall Street expectations and an investment thesis. Wall Street expectations are short-term focused, so they will reward a company like Nvidia that is delivering earnings growth right now and is likely to continue growing at a breakneck pace. However, this mindset can overlook opportunities hiding in plain sight, like Adobe.
The stock could languish for a while. However, if earnings growth accelerates, Adobe will be too good of a company to ignore and the stock could rapidly rebound. By the same token, Adobe's spending could put pressure on near-term earnings and make the figures look especially weak.
The best stock gains are not made by betting on the short term but by investing in quality companies and letting them compound over time. Buying Adobe now is a bet on the company's ability to integrate AI into its customers' daily workflows and monetize AI across its services for years to come, not whether it hits Wall Street estimates in fiscal 2024 or not. For patient investors, Adobe has what it takes to be a long-term winner.
