Adobe Inc. (NASDAQ:ADBE) saw its stock drop 3.0% to $227.77 by midday Tuesday after Morgan Stanley (NYSE:MS) downgraded the software company to underweight and slashed its price target from $365 to $240. The move came as the broader S&P 500 edged up about 0.4%, highlighting the stock's underperformance. Adobe shares are now down nearly 35% year-to-date, and the new price target offers only a 5.4% upside from current levels.
Earnings Growth Fueled by Buybacks
Beneath the headline numbers, Adobe's adjusted earnings per share (EPS) outpaced net profit growth last quarter, primarily due to a reduced share count. In the fiscal second quarter, revenue rose 12.7% to $6.618 billion, while non-GAAP net income increased 10.5% to $2.400 billion. However, non-GAAP diluted EPS jumped 17.8% to $5.96, as the diluted share count fell 6.3% to 402 million. The decline in shares outstanding accounted for roughly seven percentage points of the EPS growth gap, according to company disclosures.
Share Repurchase Program
Adobe bought back 8.5 million shares during the quarter and still has about $27 billion available under its current repurchase authorizations. That represents roughly 29% of its $91.7 billion market capitalization as of Tuesday. The authorization does not obligate the company to buy shares, but it provides a significant financial buffer.
Valuation Discount to Peers
Adobe's trailing price-to-earnings (P/E) multiple of 13.0x is well below those of selected software peers. Salesforce Inc. (NYSE:CRM) trades at 23.5x, Autodesk Inc. (NASDAQ:ADSK) at 31.2x, and ServiceNow Inc. (NYSE:NOW) at 60.1x. The median among these peers is 31.2x, meaning Adobe's multiple is 58% lower. Investors are pricing in execution risk for the company.
Leadership and Strategy Shifts
Morgan Stanley analyst Adam Wood noted that the simultaneous changes “raise the bar for execution.” He cited Adobe’s move toward offering more free entry-level products, along with leadership changes and increased investment in AI. Adobe is seeking a new CEO as Shantanu Narayen prepares to step down, and Steve Day has taken over as interim finance chief following Dan Durn’s departure in June.
Growth and AI Focus
Despite the headwinds, Adobe continues to grow. Revenue increased 13% to $6.62 billion in the quarter. Recurring revenue at period end rose 12.5% to $27.10 billion, including about $480 million from an acquisition. Recurring revenue from AI-first products more than tripled, surpassing $500 million. Creative freemium monthly users surpassed 90 million, up over 70%. Day described the freemium strategy as “the right long-term strategy,” and management delayed previously planned Creative Cloud optimizations to focus on expanding the user base.
Outlook and Risks
Adobe projects adjusted EPS for fiscal 2026 of $24.35 to $24.45. Based on Tuesday’s share price, the midpoint implies a P/E multiple of 9.3x and EPS growth of 16.5% over fiscal 2025. The current median analyst target of $240 provides limited margin for error, increasing reliance on share repurchases. Risks include a lagging conversion rate for freemium users, AI-related expenses, and leadership transitions that could hamper execution. Share repurchases are not a substitute for sustainable recurring revenue expansion.
