The expectations for many artificial intelligence (AI) stocks are extremely high. If an earnings report isn't absolutely perfect, maybe even better than perfect, investors could sell off shares, sending the stock price down.
We saw that happen with Nvidia a few weeks ago. Despite strong earnings results, management's positive outlook for the next quarter didn't top the most optimistic expectations from Wall Street. Management even gave reassurance about some of the biggest question marks around its business heading into earnings, such as its Blackwell chip rollout. Nonetheless, the share price dipped significantly after Nvidia's quarterly update. Investors who bought the dip have seen the stock come roaring back.
Now, another AI stock is presenting an incredible opportunity to buy shares on a post-earnings sell-off. Despite strong third-quarter results, Adobe(NASDAQ: ADBE) has seen its stock price fall about 12% since its most recent report. Here's why investors should consider buying or adding to a position in the company.
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Wall Street's hyper-focus on a single number
Adobe's recent stock performance has been closely tied to a single metric in its quarterly reports. Every quarter, management shares net new subscription revenue for its digital media products -- the Adobe Creative Suite and Document Cloud. It reports the number as annualized recurring revenue, or ARR.
When Adobe reported disappointing first-quarter ARR growth, shares plummeted. But second-quarter results seemed to settle the concerns of most analysts, as it handily beat expectations and provided strong third-quarter guidance. Adobe's third-quarter ARR blew past that strong guidance, coming in at $504 million.
The trouble stems from its fourth-quarter guidance. Analysts were expecting guidance of around $565 million. So, Adobe's expectations for "just" $550 million in net new ARR came as a big disappointment.
Importantly, that $15 million could've easily ended up in next quarter's report. Speaking of strong performance in the third quarter and weak guidance, President of Digital Media David Wadhwani told analysts that it closed some deals in the third quarter that it historically closed in the fourth quarter.
In other words, it pulled forward some results. Considering Adobe beat its third-quarter ARR guidance by $44 million, investors shouldn't be nearly as concerned by the fourth-quarter guidance. This looks like a case of Wall Street myopia.
Artificial intelligence is driving great results
Many investors see the proliferation of generative AI as a major threat to Adobe's Creative Suite and its overall user growth. With competitors developing new and interesting AI tools that can create photos or videos and easily edit them with natural language prompts, some say Adobe's tools will become unnecessary.
Adobe is showing the opposite is true. Generative AI is bringing more people and businesses to its creative software suite. Adobe has developed its own AI model, dubbed Firefly, and it's integrated it across its Creative Cloud. Firefly powers new features, like Generative Fill in Photoshop, Generative Remove in Lightroom, and Text-to-Template in Express. It's working on Generative Extend for Premier Pro, which would add frames to videos using Firefly.
AI features in Express, which Adobe offers for free, are driving new sign-ups. And Adobe is successfully converting those sign-ups into paid customers. CFO Dan Durn said new subscriptions are the largest contributor to its revenue growth.
That said, the ability to upsell subscribers to new products and more access to AI features has also contributed. Still, there remains a long runway for Adobe to grow by creating new AI capabilities within its software suites and asking users to pay more to use them. It's already expanded its document suite, integrating an AI assistant into Acrobat that can summarize documents, combine information from multiple documents, and generate and format content for presentations, emails, or other forms of communication.
Despite its heavy investment in AI, management has maintained a high operating margin. Last quarter's 46.5% non-GAAP (generally accepted accounting principles) margin inched higher from last year's 46.3% margin. In other words, management isn't sacrificing profitability for the sake of staving off AI-powered competitors.
After the recent sell-off, shares trade at around 28 times forward earnings estimates. While that's a slight premium to the overall S&P 500 index, it's a price worth paying for a company that's an established leader in its industry. Despite new competition, Adobe is showing it is more than capable of keeping smaller players at bay while maintaining strong growth and profitability.
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Adam Levy has positions in Adobe. The Motley Fool has positions in and recommends Adobe and Nvidia. The Motley Fool has a disclosure policy.
