In a Business Week article written in April of 2002, Scott McNealy, CEO of Microsystems, was quoted as saying the following about his company’s stock, which was trading at 10x revenues:
“At 10 times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends. That assumes I can get that by my shareholders. That assumes I have zero cost of goods sold, which is very hard for a computer company. That assumes zero expenses, which is really hard with 39,000 employees. That assumes I pay no taxes, which is very hard. And that assumes you pay no tax on your dividends, which is kind of illegal. And that assumes with zero R&D for the next 10 years, I can maintain the current revenue run rate. Now, having done that, would any of you like to buy my stock for $64? Do you realize how ridiculous those basic assumptions are? You don’t need transparency. You don’t need footnotes. What were you thinking?"
When I read that, I think of one company – Salesforce.com (CRM), which with a market cap of nearly $21 billion trades for more than 9x revenues.
Before I lump the companies together, I should point out two differences:
The first is that Salesforce.com CEO Marc Benioff wouldn’t be caught dead saying this about CRM; in between jabs at Oracle (ORCL) CEO Larry Ellison (who sends them right back), Benioff is a salesman and promoter of all things Salesforce –besides the stock: he owned 25% of the company in late 2004, and has sold for the past eight years to a single-digit stake in the company.
The second difference is that in CRM’s case, some transparency might be helpful: While the company trades at an insane multiple even on the company’s non-GAAP earnings (as Charlie Munger called them once, “bullshit earnings"), I guess it’s more helpful than the GAAP multiple (the company lost money last year, so the P/E won’t do you much good).
On the balance sheet, the company is a serial diluter, and has increased shares outstanding by more than 10% since 2009; the trend looks to continue – in the year end January 2012, the company booked nearly $230 million in expenses related to stock-based awards, or more than 10% of sales.
The examples go on and on, and interested investors should read the articles from contributors like Todd Sullivan, who has been highlighting the red flags at CRM since at least May of last year.
With all that being said, the company is pushing back towards its 52-week high, which brings me to the point of this article – when initiating a position, size it accordingly. Many people have been wrong on CRM to date, as was true on Netflix (NFLX) before it and a plethora of tech stocks at the turn of the century; others, who were spot-on, got too aggressive and ended up in a position where they couldn’t take the pain any longer (“the market can remain irrational longer than you can stay solvent”).
This idea applies to the long and the short side, and is one of the greatest lessons Buffett (BRK.B) has ever taught: patience is the fundamental trait of the greatest investors. In October 2008, Warren struck a $3 billion deal with a struggling GE, and walked away three years later with $1.2 billion in profit (and warrants good for 134.8 million shares of common at a strike of $22.25 and more than 18 months until expiration); the same can be said for the Goldman (GS) and Bank of America deals (BAC). In all three cases, his patience resulted in deals for Berkshire's owners with very little risk and sizable upside potential (I still smile everytime I think about those 700M BAC warrants...).
For those shorting CRM, I think you should be prepared that this stock will continue to climb – yes, the market can get EVEN MORE irrational; for the intelligent investor, patience and fact-based conviction will win out in the end – but make sure you don’t act too aggressively such that Mr. Market determines for you when that end will be.
About the author:
As it relates to portfolio construction, my goal is to make a small number of meaningful decisions. In the words of Charlie Munger, my preferred approach is "patience followed by pretty aggressive conduct." I run a concentrated portfolio, with a handful of equities accounting for the majority of my portfolio (currently two). In the eyes of a businessman, I believe this is adequate diversification.