Down 19% Year to Date, Should You Buy This AI Growth Stock?

Despite a sustained rally in the S&P 500 and the tech sector, Adobe (NASDAQ: ADBE) is hovering around its lowest level since June. The software as a service (SaaS) giant has had a choppy year, selling off big after reporting earnings in March, rallying after a strong quarter in June, then selling off again in September.

Adobe's fiscal-year calendar doesn't follow the earnings season of most other tech giants, so its fourth-quarter and full fiscal-year results won't be reported until Dec. 11. But Adobe's own projections call for decent, but not great results for the full-fiscal year.

Here's why Adobe has been such a poor performer relative to its peers and whether the artificial intelligence (AI) growth stock is a buy now.

Image source: Getty Images.

Adobe is drastically underperforming the benchmarks

The Vanguard Information Technology ETF, which closely mirrors the tech sector, is up 21.8% year to date (YTD), slightly higher than the S&P 500. Adobe isn't just lagging those benchmarks, it is down 19% YTD and is the worst-performing component of the top-10 holdings in the Vanguard Information Technology ETF.

NVDA data by YCharts.

Typically, the longer a sector-wide rally goes on, the more investors may be willing to scoop up shares of laggards that are out of favor if they are a better value. There may be a simple reason why that hasn't happened with Adobe.

Adobe isn't showing Wall Street the money

Adobe pioneered the SaaS business model when it introduced a subscription service for its Creative Cloud suite of apps in 2012. The business model unlocked sales and margin growth for Adobe and transformed it into one of the most-valuable enterprise-software companies.

The following chart showcases Adobe's explosive sales, earnings, and margin growth over the last decade.

ADBE Revenue (TTM) data by YCharts.

Adobe went from a low-margin company to a high-margin cash cow. But in recent years, Adobe's growth has stalled. Over the last three years, Adobe's operating expenses have slightly outpaced its sales growth, impacting margins. What's more, its diluted earnings per share (EPS) are up just 18.2% in the last three years, and that's even factoring in more aggressive stock repurchases.

If you've turned into an Adobe earnings call over the last year or two, you would have heard big promises that AI is unlocking unprecedented growth for Adobe by accelerating innovation and creating a better customer experience. But so far, Adobe's higher spending simply hasn't translated to the bottom line.

However, AI has led to some of Adobe's greatest innovation leaps in years. AI Assistant for Adobe Acrobat allows users to interact with documents by asking questions and getting tailor-made summaries, which can be useful, especially for longer PDFs (think research papers, legal documents, etc.) Adobe Firefly is a generative AI tool that converts text to images and can make AI-generated videos. These are just some of the new AI-based tools Adobe offers users to help them be more effective and efficient.

Adobe still isn't a dirt-cheap stock

Nvidia, which in many ways is the poster child of the AI-fueled growth-stock rally, has faced its fair share of criticism for being overvalued. And maybe it is. But Nvidia's results have been unbelievable, making its valuation somewhat justifiable even after the surging stock price.

The problem with a company like Adobe is that it is spending big on AI (it's a big customer of Nvidia) but so far has little to show for it. Factoring in Adobe's Q4 guidance into the results it has already reported, the company is expecting $21.43 billion in revenue and $18.27 in non-GAAP (generally accepted accounting principles) earnings per share (EPS). Compared to its fiscal 2023 results, that represents a less-than 14% increase in non-GAAP earnings. That's unimpressive for a company that is supposed to be on the cutting edge of implementing AI-powered tools into its software suite.

From a non-GAAP earnings perspective, Adobe would have just a 26.5 price-to-earnings (P/E) ratio if it achieves its full-year target. However, Adobe's actual earnings are much lower due to deferred and stock-based compensation. Adobe is buying back a considerable amount of stock to offset the impact of these expenses. But they are still a drag on earnings.

Regaining Wall Street's favor

Despite being such a key component of the tech sector, Adobe continues to miss out on the broader tech rally. The stock could continue to underperform the sector until Adobe shows more meaningful signs of earnings growth and its investments pay off.

The underperformance is an excellent example of why the broader market rally is healthy. If it were a true bubble, stocks like Adobe would soar in lockstep with other software names. But Adobe's results haven't been great, so it has been on the sidelines.

Adobe thoroughly deserves to be underperforming the benchmarks, but there's reason to believe it has what it takes to turn things around and could be a great long-term buy now. The company is the undisputed leader in software for creatives. It has a diversified suite of offerings and an excellent business model. Its recurring revenue makes its revenue stream highly predictable. This is still a high-margin business that continues to deliver record results, but it is not at the growth rate that Wall Street expects.

Patient investors may want to take a closer look at Adobe now. The stock could begin to look incredibly cheap if it returns to the 20%-plus earnings-growth rate of past years. I think Adobe could return to that level of growth once the marketplace digests some of its recent product improvements and it figures out how to properly price AI product upgrades. Until then, it's understandable if investors prefer to take a wait-and-see approach to Adobe stock.