Once threatened by the advancements in artificial intelligence (AI), shares of Adobe Inc. (NASDAQ: ADBE) are now having their best day in over four years, all because of AI. The stock is now rallying by over 15% on the company’s most recent quarterly earnings results, primarily driven by some trends that have driven the technology sector higher this year.
Analysts were surprised that one of the company’s leading key performance indicators (KPIs), annual recurring revenue, had jumped above expectations. Because of today’s unstable economic environment, predictable and steady cash flows are critical for investors to keep front and center when selecting their next potential investment into a stock.
Now that the economy is going more online, or a so-called digitalization movement, worries about copyright content are rising for companies dependent on online content and marketing or other strategies. Noticing the stratospheric growth in Adobe’s new A.I.-generated content over the year, investors can feel confident in the company’s positioning within the digital economy.
How Adobe's Strong Market Share Positions It for Future Growth
As of the most recent data, Adobe’s market share was reported to be up to 60.7% in the marketing automation solutions space. Adobe’s new cloud system is taking over the space at accelerating clips. With over 1.2 million current customers, Adobe management has a new chance to make the company as profitable as ever.
Over the past five years, Adobe’s revenue has grown by over $10 billion, as investors can note within the company’s financials. This is due to the strategic shift to a cloud-based subscription model, which is just the type of structure investors should look for in today’s market.
Before determining how the company’s growth plan can take on water, here’s a benchmark for expectations. Wall Street analysts want to see up to 12.8% earnings per share (EPS) growth in the next 12 months, backing up price targets set by these analysts today.
Slapping a valuation of up to $700 a share, those at Wells Fargo & Co. dare the stock to rally by as much as 33.5% from where it sits today, even after a double-digit earnings rally. Because the stock’s recent price action brought it to 82% of its 52-week high price, so bearish traders were sent running.
Adobe stock’s short interest collapsed by 11.6% in the past month, leaving more room for bulls to push the stock toward these analyst price targets.
Adobe's Latest Earnings Report: A Step Toward Catching Up with the Tech Sector
Digging deeper into the company’s latest quarterly results, growth trends can help the stock catch up to the rest of the technology sector. Over the past 12 months, Adobe stock underperformed the Technology Select Sector SPDR Fund (NYSEARCA: XLK) by as much as 22.2%, creating a gap for buyers to fill.
The company’s CEO started the press release by stating, “Adobe achieved record revenue of $5.31 billion..” a significant milestone for the stock to find a new path higher. This level of revenue represents a 10% growth rate over the year, but how the company made this happen is what matters to investors.
Digital Media's annual recurring revenue (ARR) exited the quarter with $16.2 billion, which is set to be added to net revenues once the subscription cycle is finished. Because of this recent boom in ARR, management felt confident in boosting 2024 ARR guidance higher.
The company now expects an additional $1.95 billion in ARR to end the year, where it only guided for $460 million in the previous quarter. Considering that this will likely fuel another double-digit rise in EPS for the next quarter, today’s analyst projections seem to be on the conservative end of the spectrum.
Apart from all the drivers that boosted the stock price, here’s another nice feature for investors to consider. With free cash flow (operating cash flow minus capital expenditures) of $1.9 billion, Adobe’s management deployed some of this capital to buy back up to 4.6 million shares from the open market.
Why Adobe Stock Remains Undervalued Despite Recent Rallies
Compared to the rest of the prepackaged software industry, Adobe stock is still undervalued based on a few valuation ratios, which is surprising considering how much it rallied post-earnings.
On a price-to-earnings (P/E) basis, Adobe’s 43.9x valuation is roughly 27.3% lower than the industry average of 60.4x.
Following along, on a price-to-sales (P/S) ratio, Adobe is valued at a 10.3x multiple, again lower by a massive 84.2% compared to the industry’s 65.3x valuation average.
Future expected growth rates are the usual driver of these valuation ratios, so Adobe’s deep discounts to the industry seem unjustified, considering how aggressively these figures are set to keep growing.
