ADBE Stock Analysis: Is Adobe Massively Undervalued?

Despite the AI-dominated tech rally over the past year, Adobe (NASDAQ:ADBE) has been a laggard in the industry. The stock is down by more than 11% year-to-date and 3.0% over the past twelve months. The sell-off in Adobe’s stock stems from its high valuation as concerns about its ability to sustain growth remain a huge question mark. Adobe’s fundamentals are solid and the company remains the industry standard for creative professionals. It also shows real profitability from generative AI, something not every company can say.

So is it worth buying right now?

AI is Moving the Needle for Adobe

Adobe might not be the first company you think of when it comes to AI, but generative AI is making a real impact on its business. The company’s Firefly AI platform has been integrated into popular products like Photoshop and InDesign. Since Firefly’s debut in March 2023, it has generated more than 9 billion AI-generated images.

In the most recent quarter, Adobe saw a 38% sequential increase in Firefly image generation from Q1. Adobe reported that its generative AI features have established themselves as the go-to software tools for the creator community. One indication of this success for Adobe is that it announced it is moving up its Annual Recurring Revenue (ARR) target to $1.95 billion due to users upgrading to higher-priced premium subscriptions with Firefly features.

Adobe Still Dominates the Creative Industry

Adobe remains the dominant player in the creative software industry with an estimated 90% of creative professionals using its products.

Tools like Canva have been gaining traction and could potentially take market share from Adobe. However, moving from Adobe to Canva or any other platform requires high switching costs.

As a comparison, apps like Canva are more simple in functionality while Adobe’s suite of products are like a separate coding language with much more robust functionality. The time invested in mastering Adobe’s apps would be wasted by moving to simpler, less functional software.

Adobe’s Advertising Business is a Liability 

Most people aren’t even aware of Adobe’s advertising business segment. As of Q2 2024, it accounts for nearly 25% of Adobe’s revenue. Unlike Adobe’s creative software market, its advertising market share is constantly being challenged by rivals like Salesforce (NYSE:CRM), Oracle (NYSE:ORCL), SAP (NYSE:SAP), and IBM (NYSE:IBM). 

Adobe Has Seen Slowing Growth 

One red flag is that Adobe’s net new Annual Recurring Revenue (ARR) growth is declining. This metric measures the number of new users that sign up for its Creative Cloud subscription each year. In Q2 2024, this growth was 3.62% year-over-year, which is a decline compared to its previous year-over-year growth of 9.3%.

Total annual revenue growth is also moderating with many analysts projecting just 10 to 11% growth per year over the next few years. This is compared to 2021 when revenue grew by more than 20%. 

Adobe Stock Valuation

Adobe’s forward price-to-earnings (P/E) ratio is 24.75x, which is considerably lower than its trailing P/E to 45.85x. 

This is neither cheap nor expensive and is right in line with Adobe’s historical average valuation. 

Wall Street Analysts are quite split as well. Out of 31 analysts, the lowest price target is $412.43 while the highest is $671.37, with the average being $560.27 which is about 10% higher than the current stock price. 

My Verdict on Adobe Stock 

Adobe has a strong user base and generative AI features are showing to be useful to its users indicating a potential opportunity for a massive stock price upside, especially if Firefly begins to generate more revenue on its own. 

The way I see it, the reason why investors aren’t hyping up Adobe’s AI segment is that it’s already an industry leader. There’s little room left for rapid growth in revenue even if consumers enjoy the AI features. 

Meanwhile, its advertising business segment and slower growth is worrisome for investors. I believe Adobe’s monetization strategy of generative AI is the key reason that determines if its stock is properly valued. For now, I’m staying on the sidelines because I don’t find its valuation particularly cheap and would prefer a bigger margin of safety to bet on Adobe’s generative AI. 

On the date of publication, Michael Que did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

On the date of publication, the responsible editor did not have (either directly or indirectly) any positions in the securities mentioned in this article.