Share prices of Adobe(NASDAQ: ADBE) sold off after the company reported its fiscal 2024 third-quarter results on Sept. 12 and management offered weak guidance for the rest of the year. The stock now trades down by more than 10% year to date compared to an over 14% gain in the tech sector and a 17.8% gain for the Nasdaq Composite.
Yet despite some notable challenges that could weigh down the growth stock in the near term, Adobe is worth buying now. Here are three reasons why.
Image source: Getty Images.
1. Overall results will likely remain weak in Q4 and for the fiscal year
Based on updated fiscal fourth-quarter guidance, Adobe management expects the company to book $21.43 billion in revenue and $18.27 in non-GAAP (generally accepted accounting principles) earnings per share (EPS) for fiscal 2024.
If it hits that goal, its revenue would be just 10.4% higher than fiscal 2023, marking another year of slowing growth. Based on its non-GAAP fiscal 2024 earnings guidance, Adobe would have a price-to-earnings ratio of 29.4, which isn't bad for an industry-leading growth company. But it's worth noting that Adobe's GAAP earnings tend to be about 30% to 40% lower than its non-GAAP earnings.
In fiscal 2023, Adobe earned $11.82 in GAAP diluted EPS, but $16.07 in non-GAAP diluted EPS. Stock-based and deferred compensation accounted for a whopping $3.78 per share -- the vast majority of the adjustment. Like other tech companies, Adobe has a sizable stock-based compensation program to attract top talent and compensate them with equity in the company. It has been increasing its pace of share buybacks to help offset the dilution caused by that stock-based compensation, but it's still an expense worth following since it heavily impacts Adobe's earnings.
In sum, Adobe's sales and earnings growth over the last couple of years have been unimpressive, especially relative to other tech companies that benefit from artificial intelligence (AI).
2. Adobe's competition is increasing
For years, Adobe reaped the benefits of owning a suite of industry-standard software programs such as Photoshop, Illustrator, Acrobat, and InDesign. Just as being proficient in Microsoft Excel or PowerPoint looks good on a business professional's resume, knowledge of Adobe's products can be a basic requirement for many jobs in the creative sector. There are a lot of advantages to being the default product in a category. However, sometimes, those advantages can lead companies to become complacent, less innovative, or operationally inefficient. Before 2023, Adobe relied heavily on its entrenched position rather than ensuring it still had the best offerings. That advantage is no longer good enough.
Competition has gone up a notch, especially in recent years. The biggest threat to Adobe is probably Canva, which is a far cheaper yet effective solution. Canva Pro is just $15 per month per person -- a quarter the price of Adobe's creative cloud. Canva has tools for document presentations, social media, videos, websites, and more. It also has generative AI tools that directly compete with Adobe's solutions.
The software in Canva's product suite is still a step below Adobe's. But if it innovates faster than Adobe, the price difference could make it a compelling alternative, giving it a greater opportunity to eat away at Adobe's market share.
3. Adobe's business model is under fire
Another threat to Adobe is its business model. Adobe launched Creative Cloud in 2012 and pivoted to offering its suite of applications via subscriptions. That was arguably the greatest decision in the company's history. The software-as-a-service business model creates predictable recurring revenue and can open the door to steady growth. However, if Adobe's product improvements eventually allow one user to do the work that used to take two or three users, then the subscription price would have to go up a lot to offset its shrinking user count.
This type of threat is something that all enterprise software companies need to be concerned about, not just Adobe. Although it's still way too early to see signs of this happening, it's still something worth paying attention to.
Adobe is still worth a closer look for 2 reasons
Despite its sluggish growth, expensive valuation, competition, and the uncertain future of Adobe's business model, I still think the stock is an excellent buy now. Here are two reasons why:
- Adobe is well-positioned to revolutionize marketing and save its customers a ton of money and time developing advertising campaigns. And if it does that, it could open the door to a completely different tier of product offerings. I could see Adobe developing a high-octane AI-powered solution for enterprises that costs thousands of dollars per year per user rather than hundreds of dollars, but adds so much value that it is well worth the price.
- Adobe stock looks expensive based on its current growth trajectory. However, it is still early in its AI development process and needs time to build out its offerings and monetize its new tools. In the meantime, Adobe is well-positioned to thrive from the need for more content in every form of digital media.
The stock's balance of risk vs. potential reward should be highly attractive for investors who believe in Adobe's ability to innovate and monetize AI. However, it could take years for the company to complete that leap. And for investors who don't think Adobe can kick its business into a new gear, I'd say it would be better to pass on the stock at this time.
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Daniel Foelber has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Adobe and Microsoft. The Motley Fool recommends the following options: long January 2026 $395 calls on Microsoft and short January 2026 $405 calls on Microsoft. The Motley Fool has a disclosure policy.
