Should You Buy Adobe After Its 40% Drop?

Adobe (NASDAQ: ADBE) shares have plunged by more than 40% year to date. The stock trades below $200, a far cry from when the stock nearly touched $700 per share.

Artificial intelligence is on most investors' minds, especially with how easy it is to create images with AI tools. However, this fear has resulted in an unreasonably low valuation for a company that is still growing.

Image source: Getty Images.

Addressing the AI concern

Software stocks sold off broadly amid concerns that artificial intelligence would replace software businesses, rendering them obsolete. Claude's Cowork demonstrated that its generative AI could replace software. While it's a major AI innovation, it's easy for investors to overestimate how quickly new technology will move and whether existing software businesses will become obsolete.

Adobe isn't the only software stock that has tumbled amid fears that SaaS companies may no longer be needed. Salesforce and Workday were both hit hard. Those two stocks have also lost more than 40% year to date.

While the surrounding narrative about Adobe and AI is that advanced technology can make Adobe obsolete, that is an extreme exaggeration that has driven the company's attractive 11 P/E ratio. Adobe's P/E ratio was in the mid-20s less than a year ago and comfortably held that position. Adobe can more than double in valuation alone.

Even the concerns about images are overblown. Getty Images proved there's little to worry about by securing a long-term deal with OpenAI. While AI is changing the digital landscape, investors are trading Adobe stock as if it were doomed to fail and wouldn't adapt.

Adobe's fundamentals point to long-term growth

Looking at Q1 results and the press release commentary makes the AI-fueled panic even more bizarre. Adobe delivered 12% year-over-year revenue growth in Q1, raised its full-year guidance, and cited "strong AI-driven demand across customer groups" as a major catalyst.

The company has a solid foundation, including $27.1 billion in annual recurring revenue. The company also generates over $500 million in annual recurring revenue from its AI segment, a figure that has more than doubled year over year.

Adobe continues to post net profit margins in the mid-20s. Its business is gaining market share despite the stock's year-to-date losses. That mismatch suggests Adobe can be a compelling long-term opportunity at current levels. Continued success with its AI products can strengthen the bullish narrative and reward investors who wait for the comeback story.

Marc Guberti has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Adobe, Salesforce, and Workday. The Motley Fool recommends the following options: long January 2028 $330 calls on Adobe and short January 2028 $340 calls on Adobe. The Motley Fool has a disclosure policy.