Is Adobe Stock a Buy, Sell, or Fairly Valued After Earnings?

Adobe ADBE released its second-quarter earnings report on June 5. Here’s Morningstar’s take on what to think of Adobe’s earnings and stock.

Adobe Stock at a Glance

• Fair Value Estimate: $485
• Morningstar Rating: 3 stars
• Morningstar Economic Moat Rating: Wide
• Morningstar Uncertainty Rating: High

What We Thought of Adobe Earnings

Both Adobe’s revenue and non-GAAP operating margin were better than expected based on broad strength in terms of segments and geographies, with both digital media and digital experience coming in ahead. Margins were good even in the face of high investment for Firefly AI. Management expects an uptick in both revenues and annualized recurring revenue in the second half of 2023, so guidance was also slightly better than expected for the third quarter and raised for the full year.

Unsurprisingly, artificial intelligence was the focus of the company’s earnings call, building off Adobe’s recent Summit announcements. Firefly in particular drew attention, with management focusing on the potential for its seamless integration into existing products, with integration announcements already made for Photoshop, Illustrator, and Express. Since the Firefly Beta launched in March, users have made over half a billion generations, with creations from Photoshop 80 times greater than Adobe projected

These results are consistent with our opinion that Adobe is a high-quality company that should be on investors’ radars. That said, software stock has performed well this year, and we view shares of Adobe as fairly valued.

Adobe Stock Price

Fair Value Estimate for Adobe

With its 3-star rating, we believe Adobe’s stock is fairly valued, in line with our long-term estimate.

Our fair value estimate for Adobe is $485 per share, which implies a fiscal 2023 enterprise value/sales multiple of 12 times, an adjusted P/E multiple of 31 times, and a 4% free cash flow yield.

We model a five-year revenue compound annual growth rate of approximately 11%. We foresee solid growth in both digital media and digital experience, even as both steadily slow over time. Digital experience should benefit from increasing penetration into what Adobe calls a $110 billion market. We believe the company has a relatively frictionless cross-selling opportunity, as creative professionals are already steeped in its products. The desire to consolidate vendors makes Adobe an obvious choice for marketing software solutions, and the fact that its products are strong should initially help in what we believe is a large greenfield opportunity. We believe continued innovation, gathering new users, and upselling existing users in Creative Cloud should help drive strong growth for the next several years.

Read more about Adobe’s fair value estimate.

Adobe Price/Fair Value Ratios

Ratios over 1.00 indicate when the stock is overvalued, while ratios below 1.00 mean the stock is undervalued.

Economic Moat Rating

For Adobe overall, we assign a wide moat arising from switching costs and network effects. Looking at the company’s individual segments, we believe digital media has a wide moat because of switching costs and network effects, digital experience has a narrow moat arising from switching costs, and publishing has a narrow moat due to switching costs.

Switching costs are the primary driver of the wide moat surrounding Creative Cloud. While there is a great variety of competitive products, Creative Cloud is so pervasive within the creative world and educational system that we believe replacing it would be an insurmountable barrier. Further, so many creative professionals use these tools that it makes it so all others in their fields must also use them. While the Creative Cloud has its issues (particularly premium pricing) and any one organization or freelance professional might be willing to switch, they would find it difficult to work within an entire industry that has standardized around it. This also helps ensure that when Adobe releases or acquires a related new solution, it too becomes widely adopted.

Through acquisitions and eventual organic feature and product development, Adobe has established itself as a leader in various categories under the digital experience umbrella, including digital marketing analytics, campaign management, and customer engagement.

Read more about Adobe’s moat rating.

Risk and Uncertainty

We assign Adobe a Morningstar Uncertainty Rating of High. Its risks vary by segment. Creative Cloud’s high market share over the last 25 years means a significant portion of high-margin revenue would be at risk (however slight) if a competitor were to make inroads in the space. The dampening of cross-selling opportunities with digital experience would then likely be diminished, which would be problematic, as we believe that segment represents the larger growth opportunity over the next five years. While Adobe is generally considered a leader in the various categories under the digital experience umbrella, it did not create any of these categories and does not dominate them the way it does with the functions that constitute Creative Cloud.

Adobe has built its digital experience business largely through acquisitions. The company’s two recent acquisitions of Magento and Marketo also pose risks, as those were on the larger side compared to the purchases it’s historically made. Any integration missteps could potentially cause delays in signing new contracts.

Read more about Adobe’s risk and uncertainty.

ADBE Stock Bulls Say

• Adobe is the de facto standard in content creation software and PDF file editing—categories the company established and still dominates.
• The shift to subscriptions eliminates piracy and makes revenue recurring while removing the high up-front price for customers. Growth has accelerated and margins are expanding from the initial conversion inflection.
• Adobe is extending its empire in the creative world from content creation to marketing services more broadly through the expansion of digital experience. This segment should drive growth in the coming years.

ADBE Stock Bears Say

• Momentum is slowing in Creative Cloud after elevated growth driven largely by Adobe’s transition to a software-as-a-service model.
• There is greater uncertainty in digital experience, given that this is an emerging space that Adobe neither created nor dominates. Growth could be slower than we anticipate, or margin expansion may not materialize.
• The digital experience segment has been built mainly through acquisition, including Adobe’s purchases of Magento and Marketo in 2018. This raises the possibility of disruption from inadequate integration efforts and lends credence to concerns the company may overpay for increasingly large deals.

This article was compiled by Maggie Guidici.

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