As the market correction continues to drag on, investors are losing patience with tech stocks, but that doesn’t mean you need to dump all your tech holdings. Even with the current troubles, some tech titans are continuing to prosper. Salesforce (NYSE:CRM) is one such company; prospects still look sunny up in its cloud. Here’s why CRM stock is a good choice in this turbulent market.
Strong Earnings Continue
It’s hard to know where to start when discussing the good news from Salesforce’s latest earnings report. The company beat on both earnings and revenues, although it did guide Q4 earnings slightly below analyst estimates. That said, Salesforce has always been more about revenue growth than earnings.
And revenue growth sparkled. The company sported 26% year-over-year growth, and its all-important subscription revenues number beat expectations handily.
Additionally, Salesforce raised guidance for both this year and the next by more than $100 million. That fiscal year 2020 guidance represents 21% revenue growth for next year.
It’s simply amazing that a business of this size and market share in its industry can continue to expand at this rate. What’s driving Salesforce’s success? There are two main long-term catalysts behind Salesforce’s continuing success.
Salesforce Co-CEO Keith Block put it well recently: “Every company in the world has a mandate to digitally transform its business.” While most large businesses in developed countries already have great web presence, this is far from the case elsewhere. Many small businesses are still struggling to adapt to changing times.
Overseas, internet penetration is still catching up to developed market levels, and many businesses haven’t established any meaningful digital strategy yet. The company’s growth in EMEA (Europe, the Middle East, and Africa) particularly reflects this, as it is running at a 31% annual clip.
At $13 billion in annual revenues, it may seem like Salesforce is running out of opportunities. But that’d be mistaken. Some analysts have pegged Salesforce’s total addressable market at $100 billion, and that’s a figure which continues to grow. Even as Salesforce’s main product matures, new adjacent offerings, such as the commerce cloud can offer rapid revenue growth.
One of the things you want with a long-term buy and hold sort of investment is strong corporate culture. This helps with obvious things, such as avoiding fraud and scandals. But it has more subtle benefits as well. Co-CEO Block explained the benefits of their culture well at a recent Barclays technology conference. Responding to a question about how the company retains employees, he stated:
“We compete with Facebook and Google and Amazon and a thousand start-ups within 3 miles of this place. So, it’s absolutely gold rush. The go-go days, we’ve had times like that in Wall Street, we had times like that in the .com era, but people want to be here because they like our values. And I could give you examples of people who have taken great jobs here who have [gotten] paid more in other tech companies, but they just appreciated the value and the transparency that we bring.”
In addition to keeping a strong workforce at a reasonable budget, Salesforce is investing heavily in R&D. This is a relatively new development. As recently as 2009, Salesforce spent just $100 million per year on R&D. This number has exploded to almost $2 billion annually now.
CRM stock bears tend to overlook Salesforce’s core strengths. They see a company that barely earns net income and claim CRM stock is expensive. But, like with Amazon.com (NASDAQ:AMZN), Salesforce’s management has invested for the future rather than trying to earn big accounting profits now. And unlike Amazon, Salesforce doesn’t have a poor reputation of relating to its employees.
CRM Stock: What’s It Worth?
Salesforce is clearly a buy and hold forever sort of investment. The big question stocks like CRM is what is a fair price? Even with great companies, if you buy at a bad price, it can take years to recoup your investment; just ask anyone who bought Amazon stock in the year 2000.
While Salesforce is inarguably a great company, it’s also an expensive stock. Bears like to point out that CRM stock still sells for 50x earnings, even with its recent return to meaningful profitability.
But the real metric to judge Salesforce by is its price to sales ratio. The market values CRM stock this way because Salesforce itself prioritizes revenue growth over earnings.
Salesforce has a highly sticky product. It’s an enormous pain for customers to switch to another customer relations vendor. Thus, at any point, if Salesforce reduced its marketing to bring in new clients, it could turn on a gusher of profits from its huge established customer base.
However, it hasn’t done this, as its enterprise becomes even more valuable as long as it can attract new clients at a reasonable price.
In any case Wall Street views CRM stock by its price to sales ratio. This ratio has been remarkably consistent. Dating back to 2006, CRM stock has always sold for between 7x and 12x sales with a brief exception during the financial crisis.
Since 2012, the range has tightened even farther, with CRM stock almost always selling for between 7x and 9x sales. It hit 9x again earlier this year, but the tech selloff has dropped it back to the bottom of the range.
CRM stock was trading for 7.6x sales earlier this week, and with Thursday’s drubbing, that number will go lower yet. For investors wanting to buy CRM stock for the long-term this is generally about as good as it gets.
And for a trade, CRM stock could easily pop back toward 9x sales, offering close to 30% upside in coming quarters.
At the time of this writing, Ian Bezek held no positions in any of the aforementioned securities. You can reach him on Twitter at @irbezek.