Adobe (ADBE) Smashes Fiscal Q3 Earnings: It's All About AI

Graphic design company Adobe (ADBE) has gone through several major changes over the years...

Adobe first started with PostScript, a programming language that allowed PCs to print documents. Then in 1989, it made the pivot to graphic design with Photoshop... And a few years later, it launched the portable document format ("PDF").

The next big business shift came in 2013. That was when Adobe moved from the perpetual license software model – where customers installed Adobe's software as a one-time purchase – to the subscription-based Software as a Service ("SaaS") model.

Just about every major pivot Adobe has made in its history has been highly profitable.

Well, Adobe is at another turning point today.

This time, it's artificial intelligence ("AI").

Investors have been waiting to see if AI would destroy Adobe's business... or if the company could profit from AI by making its products multiple times better, attracting even more customers.

After all, consumers now have their choice of free AI graphic design tools. That's a potential threat to Adobe's market share, with competitors like Figma (FIG) and Canva waiting to scoop up users.

Adobe just reported fiscal third-quarter results yesterday. And it made a statement to the investing world...

Adobe is an AI company now.

Adobe Defies Doubters With Strong Third-Quarter Performance

Adobe shot up as much as 4% after hours yesterday. But as I write, the stock is roughly flat – a confusing turnaround.

The market's first bullish reaction makes sense... because its third-quarter results were outstanding.

Sales for the quarter came in at a record-breaking $6 billion. That's slightly above the $5.9 billion that analysts expected. More impressively, it's up 11% from a year ago.

Net income surged to $1.8 billion, or $4.18 per share – up from $1.7 billion a year ago (or $3.76 per share).

Adobe also raised its guidance for the fiscal year. It's now calling for total revenues between $23.65 billion and $23.7 billion for fiscal 2025. Management's previous outlook was between $23.5 billion and $23.6 billion.

Beating earnings and raising guidance is nothing new for Adobe. The last time Adobe missed earnings expectations was back in late 2018.

Here's why many analysts are so excited about Adobe's earnings this quarter...

Customers Love Adobe's AI

Adobe launched its own generative-AI platform in 2023. It's called Firefly...

It lets users create images, audio, and videos through simple language prompts. And it turns out that Firefly – along with other Adobe AI applications – has been a big hit with customers.

From CEO Shantanu Narayen...

Adobe is the leader in the AI creative applications category with AI-influenced ARR [annualized recurring revenue] surpassing $5 billion and AI-first ARR already exceeding our $250 million year-end target.

The company also said that nearly 90% of Adobe's top 50 big business accounts have adopted one or more of Adobe's AI products. Even better, since the start of fiscal 2023, more than 40% of those accounts doubled their ARR spending with Adobe.

It's clear the graphic design world wants Adobe's AI offerings... And they're willing to pay more for it.

Firefly is free to use for basic purposes. But the company offers several plans that expand what it's able to do. The standard plan starts at $10 per month, with other subscriptions ranging from $30 to $200 monthly.

From Anil Chakravarthy, the president of Adobe's Digital Experience business...

AI is no longer a future bet, it's a competitive advantage today... The world's leading brands are betting on Adobe to scale content, speed up decision-making and orchestrate standout customer experiences at every touchpoint.

Now, arguably, the competition has AI just as good as Adobe's (or even better). But as I recently explained, you can think of Adobe like Microsoft Excel...

For major businesses, the alternatives of Excel would have to be many times better than Excel to make companies consider switching... which would mean converting years and years of data into a new format.

It's the same for Adobe. This company is entrenched in the graphic design community. Most graphic designers have grown up on Adobe products. The effort and cost of switching is just too high.

Simply put, big businesses rely on Adobe.

Adobe has another key advantage over free apps, too... licensing.

When you're creating a birthday invitation or a flyer for a yard sale, copyright protection isn't a big deal. But large companies need to watch out for copyright violations. If an AI tool is "trained" on a copyrighted photo, it might infringe on that copyright if a user asks it to generate a similar image.

Firefly solves this problem. Adobe offers a product just as good as OpenAI and Google, but its models are commercially safe. Adobe's AI is trained on content that Adobe owns or is licensed to use.

That gives businesses peace of mind. More from Chakravarthy...

They are comfortable with us. They see us as a strategic partner. Our focus on being commercially safe, it's very important to them to protect their own intellectual property. That's what makes us the logical partner for them as they transform their marketing and customer experience.

Adobe Is Trading for Incredible Value

Adobe has been out of favor this year...

The market doubted its ability to compete with free AI apps. That's a big reason why the stock is down nearly 50% since its late 2021 high.

Even after a successful quarter, we're still seeing the market's hesitancy in the fact that the stock stalled out today.

But investors who focus on fundamentals should be drooling over the opportunity. It's a chance to scoop up shares of a massively profitable company at a discount...

The best companies are ones that gush free cash flow ("FCF"). FCF is the cash a company generates from its operations minus capital expenditures. It's the amount of cash management can use to buy back stock, issue dividends, and make acquisitions.

Adobe generated $9.6 billion of FCF on $23.2 billion of sales over the past 12 months. That's a monster FCF margin of 41%. Only 19 S&P 500 companies do better.

This also gives us a useful tool to value the company. It's called the "FCF yield." You can think of this like a dividend yield... but instead of a dividend payment, FCF yield is calculated by dividing FCF by market cap. The higher the yield, the more value.

Take a look at Adobe's FCF yield over time...

Adobe doesn't pay a dividend. But it repurchased $2.5 billion worth of stock in the quarter. And it still has $8.4 billion left under its buyback program.

This is a big deal for investors...

Share buybacks are good for investors because the relative ownership stake for each investor increases. Every remaining share controls a larger portion of the company – in other words, your piece of the pie gets bigger.

The Stansberry Score likes this stock, too...

This is our proprietary stock-grading tool. It can scan up to roughly 5,000 stocks and gives each stock a score, ranging from 0 to 100, based on four main investment factors. Anything above 80 is considered a fantastic opportunity.

The Stansberry Score is 85 for Adobe, winning this stock an overall stellar grade of A+. Take a look...

The fundamentals line up. Adobe has mastered adapting to change. And now, it's pulling off yet another successful pivot in today's tech world.

After this quarter's earnings report, it's clear that AI is not the end of Adobe... It's a tailwind for the company.

One of the most profitable stocks in the market trades for incredible value today. And the market will eventually realize it.

Good investing,

Jeff Havenstein

P.S. When most people think of AI winners, they think of market darlings like Nvidia (NVDA). But here's the kicker...

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This stock market veteran founded our corporate affiliate Chaikin Analytics. He's followed by more than 800,000 readers in 148 countries. And he just went public with a surprising stock leading this new phase...

If you want to hear more, you can get the full story (and the name of his No. 1 free pick today) right here.