The story with Salesforce (NYSE:CRM) isn’t all bad. The company has multiple strong products, and it has a high level of recurring revenue. Moreover, its acquisitions have improved its existing products, and it should be able to use the current economic downturn to make new acquisitions cheaply.
Additionally, its growth appears to have started slowing before the novel coronavirus began spreading. And its operating profit actually dropped last year. Yet despite that, the valuation of CRM stock is quite high. Let’s take a look at each of these issues in more detail.
To start, Salesforce’s products are extremely customizable, centralized and easy to use. As a result, its products for sales teams are very widely used. Furthermore, the company has reported that 93% of its revenue is recurring. In other words, customers that generate 93% of its sales have signed long-term contracts with Salesforce.
Additionally, Salesforce has made some strong acquisitions. For example, its Tableau deal enhanced its products’ analytical capabilities, while Mulesoft enables companies that use older computer systems to more easily migrate to the cloud. According to Salesforce, it also helps customers more “easily map and manage systems for a complete view of data, devices, and apps.”
Finally, with nearly $8 billion of cash as of the end of January, the company is well-positioned to make more acquisitions at fairly reasonable prices.
Salesforce’s Model Weighs Down CRM Stock
Since a wide variety of firms with customer service needs and sales teams utilize Salesforce’s products, the company likely has meaningful exposure to small and medium businesses. For example, many car dealerships, restaurant suppliers and real estate firms use Salesforce’s tools.
Such businesses are likely to permanently close their doors as a result of the coronavirus and the ensuing recession. And companies that aren’t in business don’t pay their bills, whether they’ve signed long-term contracts or not. Additionally, during the heart of the last recession, CRM stock wasn’t very resilient. It sunk from $18 on May 1, 2008 to $7.74 on Oct. 1, 2008.
As I noted in a previous column, “analysts are upbeat about the ability of large cloud businesses, including those of Amazon and Microsoft, to continue growing during a recession.”
Why? Cloud infrastructure companies get the majority of their revenue from huge firms. Think large banks and other Fortune 500 companies. These are businesses that will definitely survive the recession. That doesn’t appear to be the case for Salesforce.
Meanwhile, Salesforce’s operating income actually fell to $463 million in its last fiscal year from $535 million a year earlier. Further, in February, it predicted that its revenue growth this year would fall to 23% versus last year’s 29%.
Yet CRM stock still trades at a fairly hefty forward price-earnings ratio, based on analysts’ average 2020 earnings per share estimate, of 54. And I have a feeling that the average EPS estimate will prove to be too optimistic, given the company’s exposure to the recession. As a result, the company’s real forward P/E ratio is probably more like 70 or 80.
The Bottom Line
CRM stock appears to have relatively high exposure to the recession, and shares trade at a high valuation. Further, Salesforce’s growth was slowing before the recession and the pandemic began, and its operating profit dropped in its last fiscal year.
Given these points, investors should sell CRM stock and buy the shares of either a large cloud infrastructure provider like Amazon or Microsoft, or a faster-growing cloud services company like ServiceNow (NYSE:NOW) or Workday (NASDAQ:WDAY) instead.
Larry Ramer has conducted research and written articles on U.S. stocks for 13 years. He has been employed by The Fly and Israel’s largest business newspaper, Globes. Larry began writing columns for InvestorPlace in 2015. Among his highly successful, contrarian picks have been Lyft, solar stocks and Snap. You can reach him on StockTwits at @larryramer. As of this writing, he did not own any of the aforementioned securities.