Shares in digital media technology company Adobe (ADBE -2.64%) fell by 13.8% in December, according to data provided by S&P Global Market Intelligence. There's no debate over the reason for the decline: a poorly received set of fourth-quarter earnings and guidance. However, there is a substantial debate around the future direction of its earnings and cash flow due to its artificial intelligence (AI) strategy.

Adobe's earnings and guidance

Adobe is a software company that offers digital media solutions to help creatives (photographers, video editors, and game developers) create and publish content. Its most important product is Adobe Creative Cloud. Adobe also sells "digital experience" solutions that help users measure, monitor, and optimize customer experiences.

With a gross margin of 89%, an adjusted operating margin of 46.6%, a free cash flow (FCF) margin of 36.6%, 13% year-over-year growth in digital media average recurring revenue (ARR) in 2024, and a scalable business model, there's nothing wrong with Adobe's metrics.

There's also nothing wrong with Adobe's valuation on a backward-looking basis. With almost $7.9 billion in FCF generated in 2024, Adobe trades on 24.6 times 2024 FCF. That's not expensive for a company with such a scalable business model, whereby ARR from subscriptions drops down into cash flow.

What about Adobe's guidance?

That said, investors care more about where a company and its stock are heading than where they came from. Adobe's stock was met with several price target reductions from Wall Street analysts disappointed with the 2025 guidance, which called for 11% growth in digital media ARR. In a nutshell, analysts expect more growth from Adobe on the assumption that it would increasingly monetize its growing AI solutions, which are being integrated into its solutions.

The AI debate around Adobe

One side of the argument is that Adobe should better monetize its solution, Firefly, which generates AI for creatives. From this point of view, Adobe has a significant growth opportunity in the pricing of its AI applications.

However, using Firefly's online AI art generator is currently free (although there is pricing for premium options) as management is trying to encourage adoption of the solutions. That position is disappointing some investors.

Image source: Getty Images.

On the other hand, the competition in the creative space is fierce, and if Adobe aggressively prices its AI solutions, it may lose subscribers. There's also the possibility that the AI tools used to create content could reduce the need for creative personnel at Adobe's key customers, implying less demand for its software. It's an ongoing debate that won't be resolved anytime soon. Still, there was enough disappointment around the guidance to lower the stock in December.