Cloud software giant Salesforce (NYSE:CRM) is often viewed as one of the biggest and best growth stocks on Wall Street, defined by a consistent track record of 20%-plus revenue growth, steady margin expansion and 25%-plus profit growth.
But, here’s a bit of sobering news for CRM bulls — Salesforce stock hasn’t gone anywhere over the past year. A year ago, CRM was a $145 stock. Today, Salesforce stock trades hands at $145, for a net gain of 0% over the past 52 weeks.
Perhaps even more surprising, over the past year, Salesforce has reported four straight double-beat earnings reports — three of which were double-beat-and-raise earnings reports, and all of which comprised 20%-plus revenue growth.
What’s happening here? Why has CRM stock gone nowhere over the past 52 weeks despite the company remaining on fire?
Valuation.
In plain English, the valuation sprinted ahead of the fundamentals in 2018, and the fundamentals have been trying to play catch-up ever since. The good news? The fundamentals have almost caught up. The bad news? They haven’t caught up just yet, so Salesforce stock may be stuck in neutral for a little while longer until the fundamentals do fully catch up.
The investment implication, then, is simple. Have CRM stock on your buy radar. But don’t pull the trigger yet.
Salesforce Is a Great Company
In the big picture, Salesforce is a great company.
The story at Salesforce is essentially all about two things. First, there’s the fourth industrial revolution, which in short, is a digital transformation playing out everywhere wherein everyone and everything is becoming connected. As Salesforce itself puts it, “[t]hink GPS systems that suggest the fastest route to a destination, voice-activated virtual assistants such as Apple’s Siri, personalized Netflix recommendations, and Facebook’s ability to recognize your face and tag you in a friend’s photo.” All of these are examples of how today’s world is increasingly being defined by everyone and everything being connected, all the time.
Second, there’s the secular maxim that the “customer is king.” That is, regardless of the digital, technological or economic backdrop, the customer is always king. Businesses have to constantly optimize the customer experience. In today’s connected world, the customer experience is bigger, more important, and broader than ever before, because consumers are increasingly interacting with products and services in all walks of life. As such, because of the fourth industrial revolution, businesses need more complete, robust customer experience management tools.
Salesforce provides those tools through its various cloud-hosted offerings, including Customer 360. More than that, Salesforce offers the best CRM tools in the market. As such, as businesses everywhere have poured more money into next-gen CRM tools, a big chunk of that money has made its way through Salesforce’s ecosystem.
The numbers speak for themselves. Consistent 20%-plus revenue growth rates for several years. Gross margins closing in on 80%. An opex rate that is around 60%, and has potential to fall with increased scale. Connecting all those dots, it’s easy to see that Salesforce is a great company with big profit growth potential in the long run.
Salesforce Stock Is Slightly Overvalued
The problem isn’t that Salesforce is a bad company. Rather, the problem is that Salesforce stock is simply overvalued.
Long story short, everyone and their best friend knows Salesforce is a great company. So, every investor has piled into Salesforce stock over the past several years. Last year, this “piling in” dynamic became too intense. Salesforce stock jumped into overvalued territory. Thus, even though Salesforce’s numbers have been great over the past year, CRM stock hasn’t gone anywhere, because the valuation already priced in those great numbers… and then some.
Here’s how I look at CRM stock. Customer 360 ramp over the next several years makes management’s $28 billion revenue target by FY23 look doable, and I further think that secular cloud and CRM tailwinds will push Salesforce to a $35 billion revenue total by FY25 — representing ~15% growth per year from FY20’s guided revenue base. Gross margins should power higher during that stretch thanks to Salesforce’s favorable pricing position. At the same time, the opex rate should fall some with scale, but not too much, as Salesforce will have to continue to spend big on marketing to sustain big revenue growth.
Inputting all those assumptions into my model, I think Salesforce can reasonably do about $6 in earnings-per-share by FY25. Based on an application software sector-average 35-times forward earnings multiple and a 10% discount rate, that equates to a FY20 price target for Salesforce stock of roughly $143.
Thus, while the valuation reset period is almost over in CRM stock, it isn’t fully over just yet.
Bottom Line on CRM Stock
Salesforce is a great company. But, Salesforce stock is overvalued. That’s why shares haven’t gone anywhere over the past twelve months. It’s also why shares may be range bound over the next few months. Eventually, though, the fundamentals will have caught up to the valuation — and at that point, investors should consider buying Salesforce stock.
As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.
