Adobe Stock: Analyzing the Dip and Earnings Outlook

Adobe Stock: Time To Buy The Dip (NASDAQ:ADBE)

The valuation is now reasonable, implying attainable FCF per share growth over the next decade, making Adobe a long-term buy. Adobe (NASDAQ:ADBE) stock fell by 9.1% in after-hours trading after reporting its Fiscal Q3-2024 results. However, the digital media and design software stock likely didn't deserve to fall by that much. The main reason for the fall was the lower-than-expected guidance, but it was hardly a miss. Now, you have a growing industry-leading company that's back to a reasonable valuation, and that suggests long-term upside from here. As a result, I rate the stock as a Buy. If ADBE stock falls more in the future, I'd be willing to change the rating to a Strong Buy. Adobe's Q3-2024 results beat both revenue and EPS expectations. Revenue of $5.41 billion beat estimates by $40 million and grew 11% year-over-year, while non-GAAP EPS of $4.65 beat estimates by 11 cents. Meanwhile, cash flow from operations reached $2.02 billion, up from $1.87 billion in the same quarter last year, remaining performance obligations at the end of the quarter were at $18.14 billion, and the firm bought back 5.2 million shares in the quarter. So far, so good. Here's the part investors didn't like. For Fiscal Q4 2024, Adobe forecasted revenue of $5.5 to 5.55 billion -- $5.525 billion at the midpoint. That missed analysts' estimates for $5.6 billion in revenue. Also, non-GAAP EPS is forecast at $4.63 to $4.68 -- $4.655 at the midpoint. However, analysts were expecting EPS guidance of $4.67. Essentially, the revenue guide was 1.34% lower than expected, and the EPS guide was 0.32% lower than expected. In the earnings call, Wolfe Research analyst Alex Zukin asked the following question regarding net new Digital Media ARR guidance, as he was concerned because the Q4 guide is the lowest it has ever been sequentially: The quarter itself, particularly on the Digital Media ARR looked very strong. It looked unseasonably strong because you haven't grown net new ARR sequentially in the 3Q, I think, in almost four years. So maybe just comment like what drove this unseasonable strength. Is it pricing, AI traction, and particularly the Document Cloud net new ARR? But at the same time given all the product momentum you went through in the script, it's a bit confusing to understand why the Q4 guide is the lowest it's ever been sequentially for Q4 on net new Digital Media ARR, which I think makes people a little nervous about maybe the go-forward, the next year performance. And so maybe just address this dichotomy because it looks kind of seasonally a little bit different than what we're used to. And I think it's weighing on the stock after hours. Adobe gave a response, and part of the response came from David Wadhwani, the President of the Digital Media Business. He stated that the early closure of some deals boosted Q3 at the expense of Q4, affecting the sequential growth pattern. In terms of the specifics on timing, Q3 was a little stronger than you expected, and for a good reason given seasonality. I think a lot of that can be explained by a few deals that would have historically just closed in Q4, closing earlier than expected in Q3, and that changed the dynamic in terms of the linearity that you would typically see between Q3 and Q4. Before that, he stated that the combined performance of Q3 and Q4 has met Adobe's expectations, and they are on track for a strong second half of the year. I think Adobe handled that question well, so I don't see any problems there. Thus, we're now back to the main issue of the lower-than-expected guidance. Did such a small miss warrant a 9.1% drop? Probably not, but maybe the valuation was just too high before. I don't really care about that, though, because we're looking at what the price is now, not if was too high before. Now, the valuation is reasonable, which I'll get into below. I'll be valuing Adobe using a reverse DCF calculator that I've created. Essentially, it calculates an implied growth rate that the market is expecting, and then you can decide if the stock can exceed that implied growth rate (which would make it undervalued) or not (which would make it overvalued). A more comprehensive guide can be found here. Here are the valuation inputs: I used a 3% terminal growth rate for a few reasons. First, global GDP growth is estimated at around 3% for the next few years, and that seems like a reasonable growth rate in perpetuity. But besides that, if we assume the Fed's 2% inflation rate goal is achieved, Adobe's pricing power (which can easily be proven by its very high and stable ~88% gross profit margin) could allow it to at least raise prices that slightly outpace inflation. Regarding the manual FCF per share calculation, here's how I got it (just to show you that the figure is relatively reliable, as it's not updated on most financial websites yet). I took the $2.02 billion in cash from operations in Q3 and subtracted the $57 million in CapEx to get $1.964 billion in free cash flow. To that, I added the FCF from the previous 3 quarters and got $6.55 billion in TTM free cash flow. I then used the 448 million outstanding share count provided in Adobe's Q3 report and divided the $6.55 billion by that figure to get $14.62. Looking at the screenshot below, we can see that the market is currently pricing in that ADBE will see its FCF per share increase by 12.826% per year for the next 10 years and then grow 3% per year after that in perpetuity. That seems very reasonable to me, especially considering that Adobe's free cash flow is expected to grow to $10.73 billion by Fiscal 2026 (ending in November), per analyst estimates on simplywall.st. That's 2.25 years away, and the 2.25-year CAGR from a base of $6.55 billion would be about 24.5%. It's possible that these estimates can be revised downward, but probably not by much, considering the very small guidance miss. Also, the 24.5% CAGR doesn't include the positive effect of share repurchases, so consider that as well. For reference, Adobe's levered FCF for the past five years comes in at 16.75%. The per-share amounts should be slightly higher due to the stock's falling share count over the years, which you can see below. Additionally, analysts expect low-to-mid-teens EPS growth from Adobe in the next few years, helping prove my belief that the stock can meet the implied growth rate of 12.826%. In my last article, I went a little hard on Palantir (PLTR) for its high stock-based compensation, so I didn't want to leave it out of this article. If you deduct the trailing-12-month's SBC of $1.819 billion from the $6.55 billion in FCF, you'll get $4.731 billion ($10.59 per share) of what I call "real" free cash flow. In this case, the implied growth rate jumps to 17.082%, but honestly, this still seems achievable to me based on the future free cash flow estimates. Still, let's be real. Lots of people don't bat an eye at SBC, and they value stocks based on adjusted figures anyway, so do with that information what you wish. Adobe reported solid earnings that beat both revenue and EPS estimates. However, the stock fell in after-hours trading by over 9%, even though it only missed revenue and EPS guidance by 1.34% and 0.32%, respectively. Additionally, while the Q4 net new Digital Media ARR guidance seemed weak to analyst Alex Zukin, the company reassured investors that the reason for that is due to deals that were recognized in Q3, which normally would have been recognized in Q4. After reading through the earnings report, I've come to the conclusion that the small guidance miss did not warrant a 9.1% drop. Now, the stock is trading at what I believe to be a reasonable valuation that implies 12.826% free cash flow per share growth for the next 10 years (17.082% if you remove SBC) and 3% per year after that. Based on the firm's historical growth and future growth expectations, it could exceed or meet these implied growth rates. When I see an industry leader trading at a reasonable price, I become bullish for the long term.

Adobe Stock Earnings: Priced Too Perfectly (NASDAQ:ADBE)

Even though its outlook wasn't too far off analysts' own expectations, this has been a battleground stock for a long time. Bulls call Adobe a value stock, while bears question whether this business is flying high on narrative and low on growth rates. For my part, I'm very much on the fence with Adobe, and believe that there are amply better opportunities elsewhere. Back in June, I wrote a piece titled, Picture Perfect Priced in, where I stated, I make the case that paying 26x next year's non-GAAP EPS leaves me with no room for error. Accordingly, I know I can find better stocks elsewhere, so I will stick to neutral here. As you can see above, I've been cautious about Adobe for a long time. And today's results vindicate my trepidation in recommending this stock. Here's why. Adobe provides creative, digital, and document solutions through its three main product segments: Creative Cloud, Document Cloud, and Experience Cloud. Creative Cloud offers tools for content creation like Photoshop, empowering users to produce visually compelling designs, videos, and graphics. Document Cloud focuses on document management, including editing, sharing, and signing PDFs through Acrobat. Experience Cloud helps businesses manage customer experiences with data-driven marketing tools. Adobe's strength lies in integrating these platforms, allowing seamless collaboration, content creation, and workflow management for both individual users and enterprises. In the near term, Adobe's recent AI enhancements in products like Photoshop, Acrobat, and Premiere Pro are improving user productivity and boosting customer retention. Adobe has also seen significant adoption of its Firefly AI models, which power creative features across its platforms. With continued integration of AI across its product suite, Adobe is well-positioned to further monetize AI-driven features, which could fuel future growth. Now, the main contention for investors, is AI technology a benefit or a headwind for Adobe? The rapid development of AI has lowered barriers to entry in the creative space, allowing competitors to develop similar tools quickly and sometimes cheaply. As AI simplifies content creation, many smaller, more agile companies can offer competitive alternatives at lower prices. The growing competition in AI-driven creativity tools threatens to erode Adobe's dominance, as customers seek cheaper alternatives without needing the comprehensive features Adobe provides. Given this balanced background, let's now delve into its fundamentals. Adobe's recent guidance didn't impress investors, despite guiding for 11% y/y revenue growth rates. This wasn't a big surprise, as the previous year's fiscal Q4 set a high bar. However, the Street had become overly optimistic, expecting Adobe to keep accelerating its growth into Q4 2024. Now, even if we assume that Adobe beats the high end of their own guidance, it is still unlikely to deliver more than 11% topline growth. As a result, despite all the talk about being well-positioned for AI and adapting to the modern world, this 40-year-old company is struggling to live up to the saying, 'adapt or die.' With growth slowing down, investors are now looking beyond revenue to decide whether Adobe's stock is undervalued or already priced fairly. Adobe's balance sheet carries a net cash position of approximately $1.4 billion. This is certainly enough, given that Adobe makes nearly $2 billion of free cash flow every 90 days and growing higher each quarter. But at the same time, I know of plenty of companies that are priced below $20 billion market caps, that carry the same amount of net cash on their balance sheet. This is not a lot of cash, particularly given that Adobe has been so actively repurchasing its shares this quarter. And this brings up the next big question. Is this management a good capital allocator? Because from what I see, management has spent all the free cash flow it produced in the quarter buying back stock, rather than investing in its future opportunities. That is a short-term tactic that will work for a short while, but at some point, this tech business has to figure out some new growth avenues. Presently, Adobe is on a path to deliver approximately $18.40 per share this fiscal year. Next, let's assume that Adobe's buybacks support its EPS growing by 15% y/y into fiscal 2025 (starting in December of this year). This would see Adobe's non-GAAP EPS reaching approximately $21.20 per share next fiscal year. Is this stock a bargain at 25x next year's non-GAAP EPS? What's more, keep in mind that for my estimate of $21.20 in next year's non-GAAP EPS, I have already baked in a very rosy outlook for Adobe. Simply put, I don't believe its valuation is that enticing. At this valuation, there are plenty of options outside of large-cap tech. At 25x forward EPS, I would minimally expect to see a path towards 15% topline growth, with opportunities for further cost-optimization. Not a business that has long ago fully optimized its cost structure and is now delivering low double-digit growth rates. Paying 25x next year's non-GAAP EPS for Adobe isn't a compelling thesis because the company is delivering only modest revenue growth and has already fully optimized its cost structure, leaving little room for significant upside. While Adobe's AI-driven tools are promising, competition is rising quickly, and its growth is not strong enough to justify this premium valuation. With numerous other opportunities in the market offering better growth potential, Adobe's stock feels more like a creativity bottleneck than a clear path to innovation. In short, Adobe might need to "illustrate" a better story for investors.