Down 11% YTD, Should You Buy the Dip in This AI Stock?

Adobe Systems (ADBE), with a market capitalization of $231.5 billion, is a globally recognized software company. It is best known for its creative software suite, which includes Photoshop, Illustrator, and Adobe Acrobat. With the help of artificial intelligence (AI), Adobe has established a dominant position in digital media and marketing.

While Adobe's fiscal third-quarter earnings were strong, the stock fell after the announcement. Adobe's stock is down about 11.3% year-to-date, trailing the S&P 500 Index's ($SPX)19.6% gain. Is now the right time to buy this AI software stock on the dip? Let's find out.  

Adobe's Q3 Results Were Strong 

Adobe's transition from perpetual licenses to a subscription-based model has resulted in significant revenue growth. Recurring revenue now accounts for the majority of Adobe's revenue, ensuring consistent and predictable cash flow. 

In the third quarter of fiscal 2024, subscription revenue contributed $5.1 billion to total revenue, which increased by 11% year-over-year to $5.41 billion. Revenue exceeded consensus estimates by $34.9 million.

Adjusted earnings per share (EPS) of $4.65 increased 13.7% from the same quarter last year. The remaining performance obligation (or RPO), which measures contractual revenue to be earned in the future, came in at $18.1 billion in Q3.

Adobe has made significant investments in integrating AI into its products. Last year, Adobe introduced Firefly, a generative AI tool that improves creative workflows, putting the company at the forefront of the AI-driven creative software market. This move is expected to boost subscription growth as professionals and businesses seek advanced AI tools. Firefly is now integrated into Adobe's other products, including Creative Cloud, Adobe Express, Adobe Photoshop, Document Cloud, and Experience Cloud. The company also introduced Firefly models for “Imaging, Vector, and Design,” along with a Firefly Video Model, during Q3.

Adobe’s enterprise customers in Creative and Document Cloud include Disney (DIS), Home Depot (HD), Amazon (AMZN), the U.S. Treasury Department, Google (GOOGL), Estee Lauder (EL), PepsiCo (PEP), Meta Platforms (META), and more. Adobe's investments in AI could yield stronger performance over the next few years. 

The company did not provide full fiscal 2024 guidance. However, given the macroeconomic conditions, management anticipates Q4 fiscal 2024 revenue in the $5.5 billion to $5.55 billion range, a 9.4% increase on average over the comparable quarter last year. Adjusted EPS for the year could land in the $4.63 to $4.68 range, an average growth of 9% year-over-year. 

Analysts who cover the stock predict Adobe’s full fiscal 2024 revenue and earnings to grow by 10.4% and 13.6%, respectively. Revenue and earnings could further increase by 11% and 12.4% in fiscal 2025, respectively.

What Does Wall Street Say About Adobe Stock?

Adobe stock skyrocketed last year, rising by around 77%, fueled by AI opportunities. However, the stock has lagged the market this year. Furthermore, Wall Street has downgraded the stock from a "strong buy" in 2023 to a "moderate buy" as of today. 

Despite the negative market reaction to Adobe's forecast, many analysts remain optimistic about the business's future prospects, and have reiterated their “buy” ratings.

To name a few, Bank of America Securities analyst Bradley Sills reiterated his “buy” rating with a target price of $640. Sills is impressed with the company's progress with its Firefly services, which he believes will lead to higher digital ARR (annual recurring revenue) in the coming years.

Separately, Wolfe Research analyst Alex Zukin backed an “outperform,” along with a target price of $685. Zukin believes the market has underestimated Adobe's strong quarter, and the stock price dip provides an opportunity for investors looking for a software company with strong potential in generative AI.

Out of the 31 analysts covering the stock, 22 have a “strong buy” recommendation, one analyst rates it a “moderate buy,” six rate it a “hold,” and two rate it a “strong sell.” The average analyst target price of $613.38 for ADBE implies a 15.8% upside above current levels. Furthermore, its Street-high estimate of $703 indicates the stock can rally as much as 32.8% over the next 12 months.

In terms of valuation, Adobe is trading at 25 times forward 2025 estimated earnings, which appears to be overpriced. However, it is also lower than the stock's five-year historical average P/E of 45x. 

The Bottom Line on Adobe Stock

Adobe's growth potential remains strong, fueled by innovative products, strategic acquisitions, and a robust subscription model. Its emphasis on AI integration, cloud solutions, and expansion into new markets lays a solid foundation for future success. For investors looking for stability and growth in the software industry, this dip is an excellent opportunity to buy and hold Adobe stock.

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On the date of publication, Sushree Mohanty did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.