Adobe is a top buy; solid performance and low valuation support upside if AI risk diminishes.

Adobe reported revenue growth of 13% in its most recently completed quarter and raised expectations for the full year on the top and bottom line. This is exactly what investors want to see from Adobe, just continued performance and disruption avoidance and avoiding the disaster that could be created by the rising effectiveness of artificial intelligence.

But does this still make Adobe stock a buying opportunity? I've been ranking Adobe as one of the best stocks you can buy this year. I've owned Adobe stock in my portfolio and it's been one of the worst performing stocks in that list.

So, let's take a look if it still belongs on that list or if it should observe a downgrade. Adobe reported reaching a landmark of more than 1 billion monthly active users.

And this is one of the reasons why I've suggested Adobe stands a chance at withstanding the threat from artificial intelligence. It's got a large base of users and it's got a large base of committed users, those that are power users of Adobe.

And switching to a different service even if it's lower cost would be difficult and time consuming.

And a lot of enterprises are hesitant to switch to an unproven new technology when they have something in place that already works and their employees and their whole ecosystem is based on a current technology.

The management said we are raising their fullear revenue and earnings per share guidance.

And this is exactly what you want to see from Adobe. You don't need to see blockbuster figures from Adobe for the stock price to increase and deliver great shareholder returns.

You just need to see the company hold the line, defend itself, defend its current growth rate, defend its current earnings per share growth, and withstand the threat from artificial intelligence until investors are convinced and comfortable that Adobe's business won't be taken over by artificial intelligence because the price of the stock is incorporating a huge risk factor.

And if Adobe continues to deliver steady and solid results, that risk factor diminishes and the valuation could rerate back to its normal levels of market multiple. Adobe reported 6.76 billion in third quarter revenue.

That's 13% year-over-year growth. This is excellent growth for a business that's trading at a forward price to earnings multiple of around 10. Similarly, the profit margins remain excellent.

Third quarter operating income came in at 2.35 billion. And if you divide that with the revenue of 6.76 billion, you can see their operating profit margin is around 33%. Similarly, cash flow from operations total 2.52 billion and again above 33% CFO to sales ratio.

These are excellent figures and the company just needs to continue at these levels. They don't need to accelerate revenue growth.

The business is not trading at a valuation that depends on super premium performance. The business is trading at a valuation that's incorporating a business that's likely to slow down, a likely decelerating revenue growth, contracting margins.

That's what the valuation is pricing in. So every quarter that doesn't happen is another quarter in the direction of rerating this business back to normal valuations for a business with these characteristics.

Remaining performance obligations total $22.16 billion and the forecast for the full year was increased to $26.6 billion in total revenue.

Earnings per share were increased and total ending annual recurring revenue at 10.2%. 2% expected year-over-year. Again, this is solid double digits. Anywhere near this level, 8 9 10 11 12% would be great for Adobe stock investors on total ending ARR growth.

In digging deeper into their income statement, I was happy to see Adobe increasing research and development spending, increasing sales and marketing investment. I've mentioned that they've got very strong profit margins and given the increased threat that they're facing, I would want the company to increase investment to defend itself.

And research and development is one category I want to see increased investment. Not just for research and development's sake, but for developing technologies incorporating artificial intelligence in order to reduce the need for existing customers to switch to other services.

Whatever the reason is, customers would want to switch to something utilizing AI. I want Adobe to research and development technologies to incorporate that into their own services.

That way, they can keep their customers and customers are already wanting to stay, right?

Because you just think about yourself and your own household expense, your own business expense, your own vendor relationships. Let's say you're with Apple's ecosystem or you're with Android ecosystem.

Either way, imagine switching to the other ecosystem, right? Think about all the time it would take you to and imagine if you have a family or a business to switch your entire business or your entire household to a new uh provider. That would take hours, right?

So, you'd prefer to stay with what you have, right? And in order to make you switch, they have to provide a very compelling customer value proposition. So, the existing shareholder, the existing holder of your business has an advantage and they have a incentive to keep you as a customer and they don't have to do as much to keep you as a customer as a rival has to do to take you as a customer.

So, I want Adobe to develop and incorporate these technologies to keep these customers in place to do enough to keep them from switching. In the 3 months that ended August 28, Adobe's cash flow from operations increased by more than 10% up to $2.5 billion, up from 2.198 billion.

Very healthy growth. Again, these are excellent growth rates for a business trading at these multiples. Adobe is also increasing repurchases of its common stock because the stock looks undervalued.

I can see it. You can see it. The management team can see it. So, they're using some of their cash to buy back stock.

And when I say some, I should say a lot. They generated $2.5 billion in cash flow from operations in the quarter, and they use $2.2 billion to buy back stock. So nearly all of the cash flow that they generated in the quarter they used to buy back stock.

That's how undervalued I think they see this business trading for at its current market multiple. Speaking of its current market multiple, Adobe is trading at a forward PE of just nine.

Just nine. This is roughly one-third the valuation of the average stock in the S&P 500 index. And Adobe is better than the average stock in the S&P 500 index. When you measure on revenue growth, when you measure on operating profit margin, when you measure on return on invested capital, when you measure on balance sheet strength, when you measure on nearly every financial metric that's important to investors, the one thing is the overhang from artificial intelligence.

that big risk that Adobe could lose a meaningful part of its business from some company that's incorporating artificial intelligence whether it be open AI anthropic or whether it be a different company that's incorporating AI to offer similar services that Adobe is offering at a lower price point.

That's why the stock is trading at such a cheap valuation. And so every quarter that Adobe defends itself and delivers another quarter of excellent performance like the one that they just delivered 13% revenue growth even better operating income and cash flow growth than the more justification for the company's forward PE ratio to rerate back to levels where it was historically trading for where this business historically traded at forward PE multiples above 20.

So right now it's at 9. So it's less than half of its historical average and near the cheapest you've been able to buy Adobe stock.

Similarly, if I look at the discounted cash flow valuation model I created for Adobe, I calculated a fair value of the business at 347. The current market price is 249 and I calculated an upside of 39% for Adobe stock.

So for me as an Adobe shareholder, this was a perfect quarter. This was exactly what I wanted to see. Just another solid quarter forward of maintaining existing revenue growth.

In fact, they increased revenue growth slightly. Profit margins, cash flow from operations remained healthy. A huge buyback of over $2 billion, nearly 100% of cash flow they used to buy back stock.

They increased research and development spending. I saw all the things that I wanted to see.

Of course, they recently appointed a new CEO. Uh it hasn't been too long. What I want to see next is a longer term plan from the CEO on how they plan to defend itself against artificial intelligence.

I don't expect to see that plan in the next week or two, but by the next quarterly update, I would like to see a plan from the CEO at least for the near term, right?

Maybe not a 5-year plan, but at least for the near-term, the next 3 to 12 months, what's the plan for defending against artificial intelligence?

For now, I really liked what I saw from the company. I will be reiterating my rating on Adobe stock as one of the best stocks you can buy right now.