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Adobe’s Strong Quarterly Results Drive Share Gains

We’re raising our fair value for the software stock, which upped its full-year outlook.

In this photo illustration the American multinational computer multimedia and creativity software company Adobe logo seen displayed on a smartphone with an economic stock exchange index graph in the background.
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Adobe Inc
(ADBE)

Key Morningstar Metrics for Adobe

What We Thought of Adobe’s Earnings

We are raising our fair estimate to $635 per share from $610 after wide-moat Adobe ADBE reported good second-quarter results and raised its outlook for the full year on all headline numbers. After last quarter’s big selloff, which we think was driven by disappointing net new annual recurring revenue, management also raised its full-year outlook for this metric. We were steadfast in our Adobe thesis after the past quarter and are encouraged by financial progress through the second quarter.

We think recent price increases, recent and pending important product launches, and rapid generative artificial intelligence adoption should help drive growth over the next several quarters. Changes to our model were short-term fine-tuning, while our longer-term estimates are unchanged, and we continue to see shares as undervalued.

Revenue performance was solid overall, with no obvious weak spots and notable strength in digital media. Adobe’s strategy of creating a broad demand funnel at the top with express and driving AI usage to help convert users seems to be working, as management noted strength in both new users on the digital front, better-than-expected conversions to higher-price solutions, and better retention of existing clients.

The firm also saw strength in digital, large enterprise customers, small and medium business, and international. Second-quarter revenue increased by 11% year over year in constant currency (10% as reported) to $5.31 billion, exceeding the top end of guidance at $5.30 billion. Digital media increased by 11% year over year, as reported, and effectively drove all of the upside in the quarter relative to our model, while digital experience increased by 9%.

After last quarter’s net new ARR hiccup, this quarter’s strength should allay concerns about a rapid drop-off in growth. Net new ARR in digital media was $487 million, compared with guidance of $440 million, which we view as very good.

Generative AI Solution Attracts Interest

Within digital media, we see Creative Cloud and Acrobat doing well this quarter, with better subscriber growth and good consumption within Firefly for enterprise customers in creative and strong mobile and Acrobat Sign performance. We see a recurring theme in many of these elements over the last several quarters.

Adobe’s generative AI solution, Firefly, continues to attract strong interest, with 9 billion generations thus far. It is easy to see how Adobe Express and Firefly are widening the funnel for new customers, and we think this will bode well for growth over the next several years. We see plenty of momentum within product innovation, client interest, and revenue creation. Notably, Adobe introduced various new AI-themed solutions and features during the quarter, which should support our growth estimates.

We have long been impressed by management’s ability to drive margins, even in the face of high investment levels needed to create and train foundational AI models. We think margins can grind a little higher over time but will be limited by Adobe’s already stellar profitability levels. Non-GAAP operating margin was 46.0%, compared with 45.3% a year ago.

Management returned to its characteristically excellent form with strong results and increased guidance for the full year on headline items. We think the increased outlook and quarterly strength in net new digital media ARR are the key to the stock surging in the after-market.

Third-quarter guidance includes revenue of $5.33 billion-$5.38 billion, non-GAAP EPS of $4.50-$4.55, and net new digital ARR of $460. For the full year, Adobe raised its guidance across the board, including revenue of $21.40 billion-$21.50 billion (from $21.30 billion-$21.50 billion), non-GAAP EPS of $18.00-$18.20 (from $17.60-$18.00), and net new digital media ARR of $1.95 billion (from $1.90 billion).

Adobe Stock vs. Morningstar Fair Value Estimate

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About the Author

Dan Romanoff, CPA

Senior Equity Analyst
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Dan Romanoff, CPA, is a senior equity analyst, AM Technology, for Morningstar*. He covers software, including Microsoft, Salesforce, Adobe, ServiceNow, and Amazon, among others, and also serves on Morningstar’s Moat Committee.

Before Joining Morningstar in 2019, Romanoff spent 12 years in buy-side equity research covering the technology and telecommunications sectors, most recently at Holland Capital Management. Prior to that, he spent five years in sell-side equity research as an associate analyst at UBS and a senior analyst at Credit Suisse covering various areas within technology, including hardware, software, and semiconductors. Romanoff also has worked as an auditor and in valuation services for major public accounting firms.

Romanoff holds both a bachelor’s degree in accountancy and a master of business administration in finance from University of Illinois at Urbana-Champaign’s Gies College of Business. He also holds the Certified Public Accountant designation.

* Morningstar Research Services LLC (“Morningstar”) is a wholly owned subsidiary of Morningstar, Inc

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