salesforce.com (CRM 1.05%) is a leader in customer relationship management (CRM) enterprise software, and it has built out a suite of solutions for marketing, analytics, and customer service. The company has combined strong organic growth with aggressive acquisitive behavior to deliver sustained rapid top-line expansion. The company reported sales of nearly $16 billion over the trailing 12 months, and its market capitalization of $139 billion places it in the same league as software giants Oracle, SAP, and Adobe.
Salesforce's stock started trading under $4 in 2004, and it has charged upward during the extended bull period that began in 2009, hitting $160 in September 2018. Since then, the story has been more muddled, and it sank as low $122 in November 2018. Shares were strong to start 2019 and rose as high as $167 in March, but it has bounced back and forth between the $145 to $160 range for most of the year. The stock's three-year beta is 1.23, indicating higher-than-average volatility, but the past 15 months have seen even wider price deviations.
Salesforce has great opportunities in front of it
Today, investors are bullish about Salesforce's position as a leader in the cloud market. A McKinsey study estimated that while 95% of enterprises have moved their computing to the cloud, they only migrated 20% of their workload. That means that vendors serving cloud applications still have tremendous opportunities to further monetize the future transition of data.
Image Source: Getty Images
CRM systems are central to efficiency in sales and marketing functions for every business, and Salesforce is a leader in those services. The company's focus on adding adjacent solutions further cemented its place as a go-to provider for marketing and customer analytics. Optimism around the story is easy to understand, as Salesforce is a visible leader in a space that is both high-growth and common across the global economy. The company delivered a 25.8% average revenue growth rate over recent years, and consensus estimates call for 23% revenue growth moving forward.
Valuations and speculation can lead to more volatility
Salesforce's excellent performance would suggest that it is attractive to growth investors, and the company's valuation metrics support that idea. The stock trades at a lofty forward price-to-earnings ratio of 50.2, and even its strong growth forecasts are insufficient to bring PEG below 2.0. These metrics are much higher than close peers, with even the bullishly valued Adobe sporting forward PE of 31. Its EV/EBITDA at 46.2 and price-to-free-cash flow at 37.1 further support this conclusion.
This is a common pattern among growth stocks, which invest heavily in the corporate infrastructure, product development, and marketing required to operate at a larger scale. Salesforce only became profitable two years ago, and its focus has not been on maximizing net profits to retain and distribute to shareholders. The company has also spent heavily on strategic acquisitions, acquiring Tableau, ClickSoftware, Mulesoft, Datorama, and CloudCraze over the past two years. Salesforce's resulting operating margin is only 4%, driving a 2.5% return on invested capital (ROIC), which lags the industry average of 13.8%.
Company management, analysts, and investors are all clearly focused on growth, so that will remain the primary metric by which to judge results. This opens the door to more volatility moving forward, as growth investors in stocks with speculative valuations are much warier about perceived stumbles and deceleration. The pressure to maintain growth rates is heightened by the role that acquisitions have played in recent years because prudent take-over candidates will not always be available to supplement organic expansion.
Many investors seeking significant long-term upside are likely to fancy Salesforce, but investors who cannot withstand short term volatility should steer clear. The stock is a single earnings report with lackluster sales growth or uninspiring management commentary away from dropping.
