Will Salesforce (CRM, Financial) ever live up to its market valuation?
The company's stock has done nothing but go up up and up over the last 10 years. In fact, since October 2008, the stock has produced 14x returns for shareholders, and if you own the stock, now is the time to sell. If you don't, it may be worth owning after a massive drop during the next market correction.
Salesforce has a market capitalization of $119 billion, yet only produces $723 million in net profit on $11.8 billion in revenue. It's shocking that sellers haven't targeted this stock more. Only 1.77% of the float is short. One reason traders are shy is the company continues to grow at 27% quarter-over-quarter. That level of growth is bound to make analysts salivate, yet the company hasn't financially lived up to its hype.
Since my first Salesforce article on May 30, the stock is up 24%, which makes me thankful that I'm not a short-seller. Stock markets generally go up and rarely go down, except in times of swift correction. However, in my experience, stocks like Salesforce's simply cannot go up like this forever.
Salesforce is a stellar business that has produced extraordinary financial results for its shareholders. Since 2009, it's managed to increase sales from $1 billion to north of $12 billion, growing net income from $43 million to over $723 million (turning around its losses from 2012 through 2016), and building its book value from $1.26 to $17.88 per share. And, it's a cash flow machine, generating over $2.5 billion in the last 12 months alone.
The problem is that the market has priced the stock like the company will continue this level of growth for another decade or more. Most of the company's 15 analysts rate the stock as a buy or outperform including Bank of America Merrill Lynch, BMO Capital Markets, Bernstein and Stifel. This is a mistake.
The market for customer relationship management (CRM, Financial) services may still be growing, but the total size isn't even close to Salesforce's current market capitalization. Gartner stated in April that CRM became the largest software market in 2017 and will be the latest growing software market in 2018. Of course, Salesforce is not only the leader in CRM, but in cloud based business software services. A market that Gartner also estimates will surpass $300 billion next year.
With the size of this market, competition is strong and will only intensify.
Salesforce has come a long way from paying actors to carry “anti-software” signs in front of a user conference for Siebel Systems (now apart of Oracle) back in 2000, which at the time was a leader in customer relationship management software. Salesforce has led the shift the cloud based services across the board and deserves a lot of credit for doing so, but that credit shouldn't extend to market multiples. At the moment, Salesforce trades at 166x earnings, 10x sales and 8.9x book value. Yet, while its growth has been stellar, the profit margins and returns on capital have been lackluster, never rising past single digits and in many years turning negative.
It's concerning that to further growth it may need to continue spending 95% of its gross profit. That's unlike other ultra successful software companies that tend to have very good profit margins and returns on capital. Ultimately, Salesforce's business value could justify its market value, but investors buying into this stock right now could see a 50-70% decline during the next market correction.
Disclosure: I am not long/short CRM.
