If you wait for this high-flying stock to fall, you may end up losing money.
Companies at the forefront of artificial intelligence innovation can experience rapid share price fluctuations. Stocks can spike on strong earnings, and that momentum can keep the stock price rising for weeks or months. When that happens, it can be very tempting to wait for the stock price to fall, but waiting can cost you.
Recent examples of AI-related stocks that have skyrocketed in a short period of time include: Adobe (ADBE -1.05%)Strong earnings reports, a positive outlook from management, and a continued rise in the overall stock market have pushed the stock up 27% since the beginning of June, but even after these latest gains, investors should still consider adding this stock to their portfolios.
Adobe’s AI-powered future
Adobe’s stock price began to rise after the company reported strong second-quarter results last month. Revenues rose 10% year over year, and adjusted earnings per share (EPS) rose 15%, beating analysts’ expectations. Additionally, management now expects earnings per share of $4.50 to $4.55 for the current quarter, also beating expectations.
The latest report also allayed investor concerns about slowing average recurring revenue (ARR) growth. First-quarter ARR growth was disappointing, and management’s guidance of just $440 million in net new ARR in Q2 didn’t help. However, Adobe beat expectations, bringing in $487 million in new subscription revenue last quarter. Management is forecasting $460 million in ARR for Q3.
It’s a sign that Adobe’s AI initiatives are starting to bear fruit. The company’s generative AI is called Firefly and is trained on Adobe’s own dataset, which includes Adobe Stock imagery. Firefly’s features include Generative Fill and Generative Expand in Photoshop, Text to Vector in Illustrator, and Remove Object in Lightroom.
Adobe offers limited free use of these features in all versions of its software suite, including Adobe Express, which is also free to use. The company is currently seeing great success in attracting free users and converting them to paying users. Express users sign up for paid subscriptions, and paying subscribers pay extra to use Firefly’s more features. All of this is leading to strong ARR growth.
The company is now working to replicate that success with its Document Cloud and marketing platform. Launched in April, Acrobat AI Assistant can summarize documents and answer questions based on their content. It also offers an AI assistant that can automate marketing tasks, simulate results and generate new target audiences with natural language commands.
AI is Adobe’s friend, not foe
Some see the growth of generative AI as a threat to Adobe, as AI-powered tools make it easier to create and edit digital images. But Adobe has several competitive advantages, and its pricing power will be difficult to replace and maintain.
First, Adobe’s software is the industry standard. This creates a network effect where everyone in the creative industry needs Adobe products to share files. If you’re a designer sending files to a client, you better have an Adobe subscription so the client can see everything properly and easily edit and tweak it to their needs.
Adobe’s software suite is very static because it’s the industry standard. Switching your company’s software just to save a few dollars a month is a big risk. You’ll have to retrain your existing employees. New employees will be familiar with Adobe products but may not be familiar with other products. Plus, they may end up being less productive.
Adobe’s strength in AI is that it has access to data that others don’t, including the Adobe Stock image library on which to train its models, and the company’s large user base also provides powerful feedback that can be used to inform the next iteration of its Firefly service.
Both advantages are virtuous cycles that will only increase in strength over time, making them difficult to overcome even if new competitors roll out new AI features before Adobe does.
It’s not too late to buy stocks
Despite the recent share price rally, Adobe shares are still trading at a fair price.
Revenue growth is driven by a combination of price increases, upselling Firefly features, and strong conversion of free users, while operating margins have room to grow as scale continues and management is using excess cash flow to repurchase shares, which combine to drive strong EPS growth.
Wall Street analysts are currently forecasting 23% earnings growth this year and more modest growth rates over the next five years. But analysts may be underestimating Adobe’s long-term position and the ability of its AI capabilities to attract new users who weren’t previously in the market for its software. As a result, Adobe could be able to sustain much higher earnings growth over the long term, which would make its current price-to-earnings multiple of 31 times look cheap.
