Wait for High-Flying Cloud-Based Salesforce Stock to Fall

Currently, Salesforce (NYSE:CRM) is going from strength to strength in terms of its revenue and operating earnings. Its focus on helping business clients “digitally transform” themselves in all aspects of cloud marketing and analysis is working extremely well. But CRM stock is priced for perfection.

CRM Stock: Wait for High-Flying Cloud-Based Salesforce Stock to Fall

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Salesforce has a market value of almost $135 billion. Stripping away all the hype about its sales growth, its actual free cash flow (“FCF”) was only $2.06 billion in the last six months ending in July. So its valuation is 33 times annualized FCF.

It’s also priced at 50 times future earnings per share, another high-flying valuation for CRM stock.

Now to be fair, free cash flow is up 26.5% year-over-year. This is a very respectable growth rate. But it has to continue to accelerate to justify these high valuation metrics.

There is another reason why the market keeps CRM stock’s valuation so high.

SaaS Revenue Gets Valued Higher In Stocks like Salesforce

The market loves subscription revenue companies like CRM. About 94% of CRM’s revenue is Subscription-as-a-Service (“SaaS”).

These SaaS clients tend to be sticky. It becomes a big hassle for a large company like Adobe (NASDAQ:ADBE) to switch out of Salesforce’s marketing system software. When the renewal comes around for the software contract, the decision is usually “stay.”

In fact, analysts and CRM itself use a special metric to measure this “stickiness.”

Remaining Performance Obligation (RPO) Is Key for CRM Stock

Analysts use a non-GAAP accounting measure called “Remaining Performance Obligation” (“RPO”) to measure future sales growth. This includes unbilled and non-accrued deferred revenue which will be billed within the next 12 months. CRM calls this “current RPO.”

This metric also includes as unbilled, non-accrued deferred revenue (“non-current RPO”) which won’t be billed within 12 months. This is effectively the remainder of the signed life of subscription contracts. This non-current RPO is a measure of how many years of built-in revenue (upon renewal) can be expected and later billed. The total of current and non-current RPO equals total RPO.

Here’s what analysts love about Salesforce: its total RPO grew by 20% to $25.7 billion by the end of the second quarter (July). CRM stock can count on $25 billion in future revenue if it does not bring in any new SaaS clients.

In fact, CRM’s current RPO — i.e. the dollar amount of sales that can be expected over the next 12 months — is now $12.1 billion. Keep in mind that in Q2 CRM had $4 billion in sales, or $16 billion annualized. So three-fourths of the next fiscal years’ sales are already “in the bag” as current RPO.

Salesforce “bakes in” its growth with sticky subscription revenue. So growth is almost unavoidable. CRM has to bring in only one-quarter of last year’s new client base. That would match the previous year’s growth rate in sales.

That’s why the market is willing to place such a high valuation on the Salesforce stock. So why am I recommending not buying CRM stock right now?

The Market Has a Love-Hate Relationship with CRM Stock

The truth is that analysts hate high-flying names like Salesforce stock at market lows. For example, in 2018 CRM rose 55.5% at the peak of the “love” cycle. But by the end of the year, it was up only 31.7% for the year.

This same love-hate thing happened this summer. CRM stock fell from its high of $167.56 to a summer hate-low of $139 and change.

The market gets nervous about overpaying for the company’s expected growth. You can see this in a CNBC roundtable where analysts were negative at the end of last year on the stock right at its bottom.

Guidance for CRM Stock Is Attractive, But Be Wary of the Valuation

Salesforce provided guidance for its Q3 and full fiscal year on page 5 of its Q2 earnings presentation. CRM forecasted revenue growth of 26 to 27% and current RPO growth of 24-25%.

The problem is these numbers do not show growth that is accelerating. But CRM stock’s high-flying valuation assumes incrementally higher growth rates.

Therefore I suspect CRM stock is vulnerable to any downdraft in the general market. This is especially so if there is a possibility of a slow-down in corporate profits growth.

In summary, pick your spot with CRM stock. You can buy it at a cheaper price sometime in the future. The market is valuing the expected growth at a high price right now.

As of this writing, Mark Hake, CFA does not hold a position in any of the aforementioned securities. Mark Hake runs the Total Yield Value Guide which you can review here.  The Guide focuses on high total yield value stocks and was launched on August 30. Subscribers during September receive a 20% discount, plus a two-week free trial.

Article printed from InvestorPlace Media, https://investorplace.com/2019/09/wait-for-high-flying-salesforce-crm-stock-to-fall/.

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