This artificial intelligence (AI) growth stock looks like a great opportunity after a 12% sell-off following earnings

Expectations are extremely high for many artificial intelligence (AI) stocks. If the earnings report is less than perfect, or perhaps even better than perfect, investors may sell the stock, causing the share price to fall.

We saw it happen Nvidia a few weeks ago. Despite the strong financial results, management’s positive outlook for the next quarter fell short of Wall Street’s most optimistic expectations. Management even gave some of the biggest question marks surrounding its business a heads-up ahead of earnings, such as the launch of Blackwell chips. Nevertheless, the stock fell significantly after Nvidia’s quarterly update. Investors who bought the stock after the drop saw the stock come back with a vengeance.

Now, another AI stock is providing a great opportunity to buy shares after the earnings sell-off. Despite strong Q3 results, Adobe (NASDAQ: ADBE) has seen its share price drop by about 12% since its last report. Here’s why investors should consider buying or adding to a position in the company.

Wall Street’s Excessive Focus on One Number

Adobe’s recent stock performance has been closely tied to a single metric in its quarterly reports. Each quarter, management shares new net revenue from subscriptions for its digital media products — Adobe Creative Suite and Document Cloud. It reports the number as annual recurring revenue, or ARR.

When Adobe reported disappointing ARR growth in the first quarter, the stock fell sharply. However, the second-quarter results seemed to allay most analysts’ concerns, as they easily beat expectations and provided strong guidance for the third quarter. Adobe’s ARR in the third quarter exceeded those strong guidance, reaching $504 million.

The problem stems from the fourth-quarter forecasts. Analysts had been expecting forecasts of around $565 million. So Adobe’s expectations of “only” $550 million in net new ARR turned out to be a huge disappointment.

Importantly, that $15 million could easily be included in next quarter’s report. Speaking about the strong third-quarter results and weak outlook, Digital Media CEO David Wadhwani told analysts that several deals were closed in the third quarter that historically closed in the fourth quarter.

In other words, it advanced some results. Given that Adobe beat its third-quarter ARR estimates by $44 million, investors shouldn’t be all that concerned about the fourth-quarter outlook. It looks like a case of Wall Street shortsightedness.

Artificial intelligence brings great results

Many investors see the proliferation of generative AI as a serious threat to Adobe Creative Suite and its overall user growth. As competitors develop new and interesting AI tools that can create photos or videos and easily edit them with natural-language prompts, some argue that Adobe’s tools will become redundant.

The story continues

Adobe is showing the opposite. Generative AI is attracting more people and businesses to its creative software suite. Adobe has developed its own AI model, called Firefly, and integrated it into Creative Cloud. Firefly supports new features like Generative Fill in Photoshop, Generative Remove in Lightroom, and Text-to-Template in Express. It’s working on Generative Extend for Premier Pro, which would add frames to videos using Firefly.

The AI ​​features in Express, which Adobe offers for free, are driving new sign-ups. And Adobe is effectively converting those sign-ups into paying customers. CFO Dan Durn said new subscriptions are the biggest driver of revenue growth.

That said, the ability to sell new products to subscribers and have greater access to AI features have also contributed to this. Still, Adobe has a long way to go, building new AI capabilities into its software suites and asking users to pay more to use them. It has already expanded its document suite by integrating an AI assistant into Acrobat that can summarize documents, combine information from multiple documents, and generate and format content for presentations, emails, or other forms of communication.

Despite the large investment in AI, management has maintained a strong operating margin. The non-GAAP (generally accepted accounting principles) margin in the latest quarter was 46.5%, up slightly from last year’s margin of 46.3%. In other words, management is not sacrificing profitability to scare off AI competitors.

After the recent sell-off, the stock is trading at about 28 times estimated earnings. Although that is a small premium to the overall S&P500 index, is a price worth paying for a company that is a recognized leader in its industry. Despite new competition, Adobe is showing that it is more than capable of keeping smaller players at bay while maintaining strong growth and profitability.

Is it worth investing $1000 in Adobe now?

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Adam Levy holds positions at Adobe. The Motley Fool holds positions at and recommends Adobe and Nvidia. The Motley Fool has a disclosure policy.

This artificial intelligence (AI) growth stock looks like a great opportunity after a 12% sell-off following earnings was originally published by The Motley Fool