For the past several years, cloud giant Salesforce.com, Inc. (NASDAQ:CRM) has done nothing but grind higher.
At the start of the decade, this was a $15 stock. Today, Salesforce stock is up around $120.
That is a big move higher. And Salesforce stock hasn’t slowed down much recently. Over the past year, the stock is up nearly 40%. Year-to-date, it’s up more than 15%, which is really impressive considering the turbulent market backdrop (the S&P 500 is down on the year).
How much more firepower does this rally in CRM stock have left?
In the long-term, quite a bit. This is a big growth company dominating secular growth markets, and there are huge margin drivers that should supercharge earnings growth.
But in the near-term, Salesforce stock looks a bit expensive. I’m not so sure there will be a big pullback (investor demand for winning cloud stocks remains super high), but risk outweighs reward at current levels.
Here’s a deeper look.
Salesforce Is A Dominant Player In Big Growth Markets
As the Customer Relationship Management (CRM) industry has shifted to the cloud, Salesforce.com has become the dominant CRM company in the world. While other big CRM players continue to cede market share, Salesforce continues to gain market share at a rapid pace thanks to the company’s all-in-one, cloud-hosted CRM solution that is second to none.
And this solution is only getting better. Namely, the company is now thriving in the overlap of cloud and data.
At its core, CRM leverages data and analytics to deliver robust cloud solutions to enterprises that want data-driven insights on their customers. The volume of data globally is exploding higher right now, thanks to the mainstream emergence of the Internet-of-Things (IoT). The more valuable data there is floating around the world, the more companies turn to that data to provide insights. Moreover, the more companies that digitize their businesses, the more they will turn towards cloud solutions.
Thus, as the volume of data produced daily continues to explode higher and as businesses pivot to cloud-hosted solutions, demand for Salesforce’s suite of products will only grow.
That is a robust growth narrative. The explosion of data and cloud-hosted solutions are two things that are very likely to continue over the next five to ten years.
Moreover, the company is adding a hyper-growth component to the mix through its acquisition of Mulesoft Inc (NYSE:MULE). Mulesoft is a hyper-growth hybrid cloud player that is thriving because enterprises aren’t going all cloud. The most popular option in this cloud transition is the hybrid cloud, which is a mix of cloud and on-premise solutions. Mulesoft provides solutions which tie together those cloud and on-premise solutions. Essentially, they create data communication networks for the hybrid cloud.
Because of its exposure to the hybrid cloud, Mulesoft grew revenues by around 60% last year.
All together, Salesforce already has emerged and is continuing to emerge as the dominant player in some very big growth markets.
But Salesforce Stock Looks Richly Valued Here and Now
Because of that robust long-term growth narrative, Salesforce stock will inevitably be higher in five years than where it is today.
But not that much higher.
Revenue growth at CRM isn’t slowing by much. But it is still slowing. From 34% a few years back to 25% last year. The Street is looking for 21% growth this year, and 19% the year after that. Thus, over the next five years, CRM should be able to grow revenues around 20%-per-year.
Operating margins are exploding higher. They’ve grown by roughly 150 basis points per-year over the past several years, and are expected to grow another 125 to 150 basis points next year. This is a high-margin business that should be able to scale margins rapidly as growth rates decelerate.
Thus, I think it’s pretty likely that the company ramps margin expansion to roughly 200-basis-points-per-year over the next five years as revenue growth comes down. That would lead to operating margins of 24.5% in five years.
A 20% revenue growth rate over the next five years and margin expansion to 24.5% implies revenues of $26.1 billion and operating profits of $6.4 billion in five years. Taking out 21.5% for taxes and dividing by a presumably higher share count of 775 million, you arrive at roughly $6.50 in EPS in five years.
The market-average forward earnings multiple for growth stocks is right around 19. But CRM stock isn’t just a growth stock. It’s a big growth stock, like an Alphabet Inc (NASDAQ:GOOG, NASDAQ:GOOGL) or Facebook, Inc. (NASDAQ:FB). Pre-data breach concerns, those stocks were trading around 25-times forward earnings.
A 25-times multiple on those $6.50 earnings implies a four-year forward price target of roughly $163. Discounting that back by 10%-per-year, I arrive at a present value of roughly $110 for Salesforce stock.
Bottom Line on CRM Stock
CRM has upside in a long-term window. But in the near-term, CRM stock appears to have overshot itself. I expect the stock to undergo some turbulence here and now. That turbulence should be bought if the stock drops down to around $110 and lower.
As of this writing, Luke Lango was long FB and GOOG.
