Adobe, the industry-leading software company, has experienced a significant surge in its stock price following strong earnings and positive outlook from management. Shares of Adobe have soared 27% since the beginning of June, driven by robust revenue growth and the continued bullish market sentiment.
The company’s recent financial report showcased a 10% year-over-year increase in revenue, surpassing analysts’ expectations. Adjusted earnings per share (EPS) also saw a notable 15% rise. Furthermore, Adobe’s management anticipates generating between $4.50 and $4.55 per share in the current quarter, exceeding market projections.
Investor concerns regarding slowing average recurring revenue (ARR) growth were put to rest with Adobe’s latest report. The company surpassed its own outlook by bringing in $487 million in new subscription revenue last quarter, compared to the projected $440 million. Management is now guiding for $460 million in ARR for the fiscal third quarter, indicating the positive impact of Adobe’s AI initiatives, particularly its generative AI named Firefly.
Firefly, trained on Adobe’s proprietary data set, including Adobe stock images, has introduced features like Generative Fill and Generative Expand in Photoshop, Text to Vector in Illustrator, and Remove Object in Lightroom. These features are offered for limited use across all versions of Adobe’s software suite, including the free-to-use Adobe Express. The success of attracting and converting free users into paying subscribers has contributed to strong ARR growth.
Adobe’s AI efforts extend beyond its creative software suite. The company has introduced the Acrobat AI Assistant, which can summarize documents and answer questions based on their content. Additionally, Adobe offers an AI assistant for marketing tasks, enabling automation, outcome simulation, and the generation of new target audiences through natural language commands.
While the growth of generative AI in the digital image creation and editing space may be seen as a potential threat to Adobe, the company possesses competitive advantages that make it difficult to displace. Adobe’s software is an industry standard, creating a network effect where professionals in the creative industry rely on Adobe products for seamless file sharing and editing. Switching to alternative software would require retraining and could result in inferior production capabilities. Moreover, Adobe’s access to unique data, including its Adobe Stock Image Library, and its sizable user base provide valuable feedback for enhancing its AI offerings.
Despite the recent surge in stock price, Adobe shares are still considered reasonably priced. The combination of price increases, upselling Firefly features, and successful conversion of free users has been driving revenue growth. With room for expanding operating margins and ongoing share buybacks, Adobe is poised for strong earnings per share (EPS) growth.
While Wall Street analysts currently project a 23% earnings growth for this year and a more modest growth rate over the next five years, there is a possibility that they may be underestimating Adobe’s long-term potential and the ability of its AI features to attract new users. This potential could result in sustained higher earnings growth, making Adobe’s current forward price-to-earnings ratio of 31 appear undervalued.