After Earnings, Is Adobe Stock a Buy, a Sell, or Fairly Valued?

Adobe ADBE released its fiscal first-quarter earnings report on March 6. Here’s Morningstar’s take on Adobe’s earnings and stock.

Key Morningstar Metrics for Adobe

• Fair Value Estimate: $590.00
• Morningstar Rating: ★★★★
• Morningstar Economic Moat Rating: Wide
• Morningstar Uncertainty Rating: High

What We Thought of Adobe’s Earnings

• Results were ahead on the top and bottom lines. Acrobat and artificial intelligence-related solutions like Gen Studio, Firefly, and Acrobat Assistant all did well. Firefly was used to create 20 billion images/assets (including video clips), up from 16 billion last quarter.
• Management revealed its generative AI annual recurring revenue is $125 million, and it expects that to double by the end of the year. They do not plan to regularly update investors on this metric, but it’s a good look under the hood. Management also provided some new metrics, mainly revenue by client size for Digital Media.
• On the flip side, the company stopped providing detailed revenue about Creative Cloud and Acrobat.
• Guidance for the second quarter was in line on the top and bottom lines. Previous full-year guidance was reiterated, which we view as positive, since management typically issues full-year guidance during the fourth-quarter call and then doesn’t comment further on it until later in the year.

Fair Value Estimate for Adobe

With its 4-star rating, we believe Adobe’s stock is undervalued compared with our long-term fair value estimate of $590 per share, which implies a fiscal 2025 enterprise value/sales multiple of 11 times, and an adjusted P/E multiple of 29 times.

We model a five-year revenue compound annual growth rate of approximately 10%, with solid growth in digital media and digital experience, even as both steadily slow. Digital experience should benefit from 2023 price increases that should filter in over the course of several years and increasing penetration into an enormous market as defined by Adobe. We believe a relatively frictionless cross-selling opportunity exists for the company, as creative professionals are already steeped in Adobe products.

Read more about Adobe’s fair value estimate.

Economic Moat Rating

For Adobe overall, we assign a wide economic moat arising from switching costs. Looking at individual segments, we believe digital media has a wide moat and digital experience has a narrow moat, also arising from switching costs. We believe Adobe’s moat will allow the company to earn returns in excess of its cost of capital over the next 20 years.

Read more about Adobe’s economic moat.

Financial Strength

We believe Adobe enjoys a position of excellent financial strength arising from its strong balance sheet, growing revenue, and high and expanding margins. As of November 2024, Adobe has $7.9 billion in cash and equivalents, offset by $4.2 billion in debt, resulting in a net cash position of $3.7 billion. Adobe has historically generated strong operating margins. Free cash flow generation was $7.9 billion in fiscal 2024, representing a free cash flow margin of 37%.

We believe that margins should continue to grind higher over time as the digital experience segment scales. Adobe reinvests for growth, repurchases shares, and makes acquisitions. The company does not pay a dividend. Over the last three years, Adobe has not made meaningful acquisitions, which we think is more a function of a hostile regulatory environment, and it has spent approximately $17.9 billion on buybacks.

Read more about Adobe’s financial strength.

Risk and Uncertainty

We assign Adobe a High Uncertainty Rating. The firm faces risks that vary by segment. Creative Cloud’s high market share over the last 25 years means a significant portion of high-margin revenue would be at risk if a competitor were to make inroads in the space. The dampening of cross-selling opportunities with digital experience would likely then be diminished, which would be problematic, as we think that segment represents the larger growth opportunity over the next five years.

While Adobe is generally considered a leader in the various categories included under its digital experience umbrella, it did not create any of these categories, and it does not dominate them the way it does with Creative Cloud.

Read more about Adobe’s risk and uncertainty.

ADBE Bulls Say

• Adobe is the standard in content creation software and PDF file editing—categories it created and still dominates.
• The shift to subscriptions eliminates piracy and makes revenue recurring while removing the high upfront price for customers. Growth has accelerated and margins are expanding from the initial conversion inflection.
• Adobe is extending its empire in the creative world from content creation to marketing services more broadly through by expanding its digital experience segment, which should drive growth in the coming years.

ADBE Bears Say

• Momentum is slowing in Creative Cloud after elevated growth driven largely by the model transition to software as a service.
• Digital experience is an emerging space, and one that Adobe neither created nor dominates. Growth could be slower than we anticipate, or margin expansion may not materialize.
• Digital experience has been built largely through acquisition, including Magento and Marketo in 2018. This raises the possibility of disruption from inadequate integration efforts, and lends credence to concerns that Adobe may overpay for increasingly large deals.

This article was compiled by Aman Dagra.