Salesforce Stock Will Need Spectacular Earnings to Keep Moving Up

Salesforce stock - Salesforce Stock Will Need Spectacular Earnings to Keep Moving Up

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In the bull market of the past few years, we’ve seen a lot of stocks like (NYSE:CRM), particularly in tech. From a business standpoint, owning Salesforce stock seems like a no-brainer. is a dominant business with a base of high-margin customers that almost cannot leave its platform. From a valuation standpoint, however, CRM stock gets a little more tricky.

After all, CRM stock still trades at 49x next year’s earnings. Even that figure uses non-GAAP estimates which back out substantial stock-based compensation. It’s a multiple that suggests double-digit growth for years if not decades to come.

Of course, Salesforce stock isn’t the only stock out there with the “good business, questionable valuation” combo. Investors can, and have, said the same things about stocks like (NASDAQ:AMZN) and Netflix (NASDAQ:NFLX).

Other SaaS plays like Veeva Systems (NYSE:VEEV) and Splunk (NASDAQ:SPLK) have even higher valuations.

Salesforce and Valuation

Over the past few years, those valuation concerns largely have been ignored. Investors who focused on the numbers as opposed to the charts or the growth missed out on big gains. Worse yet, some investors entered into losing short positions.

I asked this summer if that could continue for CRM stock and similar issues and of late, the trend has reversed. Salesforce stock has pulled back 18% since the beginning of October and other high-flyers have done even worse.

So with CRM stock heading into earnings on Nov. 27, the question remains: what is the market willing to pay for these stocks? Salesforce’s own earnings may help answer that question.

CRM Stock Sells off Along with Tech

Ahead of earnings, it’s worth remembering that it could be worse for CRM. Shares are down 18%, which isn’t great. But AMZN is down 22% from its highs. NFLX has pulled back another 25% after plunging following Q2 numbers in July. SPLK has dropped 23% from early September levels.

That said, investors have given a bit of a pass to the quality SaaS plays, particularly on the enterprise side.

Workday (NASDAQ:WDAY) is down only 14%, Intuit (NASDAQ:INTU) 8.5%, and Adobe Systems (NASDAQ:ADBE) 14%. There’s clearly been a correction – but CRM’s closer peers suggest something like than a bloodbath, or even a major sell-off.

Salesforce Stock into Earnings

And so it sets up an interesting argument about just how well Salesforce stock is positioned into earnings.

Clearly, investors haven’t completely tossed away their collective willingness to pay big multiples for out-year recurring revenue and profits. Yet CRM stock, at least relative to the most quality plays on the enterprise side, seems to have taken the biggest hit.

At the same time, it’s abundantly clear that this market is not nearly as confident as it was just a few months ago. Bears are getting louder and money has moved to the sidelines. Salesforce stock may have pulled back, but it’s still a long way from cheap.

So how does the market react to earnings? History suggests that CRM numbers should come in ahead of consensus; the company hasn’t missed Street estimates in either revenue or earnings in at least five years.

Does a strong quarter remind investors of why they were willing to pay 50x+ forward earnings last year? Or are the valuation concerns large enough that anything short of a colossal beat doesn’t really change the core problem here?

Salesforce Earnings Will Matter

Traders better than myself can choose a side. But it’s the reaction to Salesforce earnings, rather than the numbers themselves, that might be the most interesting aspect of the release.

The business model here doesn’t really have a lot of room for variance, particularly on the revenue side. Churn is low and the subscriber base large; the revenue growth rate here has been almost uncannily consistent in the 25-27% range since 2015.

But how traders respond to the quarter could signal how tech, in particular, is going to trade over the next couple of months. Workday and Splunk report the same week, and Adobe follows on Dec. 13.

After that, through the holidays, there’s about five weeks where tech is going to trade on its own. In this market, that might not be a good thing. How CRM stock itself trades after earnings will give a better clue.

As of this writing, Vince Martin has no positions in any securities mentioned.

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