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This article was originally published on Simply Wall St News
salesforce.com, inc. (NYSE:CRM) recently released a strong earnings report, and the market responded by raising the share price.
While the numbers were good, we found some underlying problems once we started looking at what drove earnings.
From the chart above, we can see that Salesforce has a strong history of revenue growth, but has only recently started making profits. From the perspective of shareholders, profit is the bottom line that pays, and a company is valued through the lens of current and future profit capacity. That is why, we want to know if the company will deliver on quality profits in the future.
One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. In fact, salesforce.com increased the number of shares on issue by 7.8% over the last twelve months by issuing new shares. That means its earnings are split among a greater number of shares.
Per share metrics like EPS help us understand how much actual shareholders are benefitting from the company's profits, while the net income level gives us a better view of the company's absolute size.
Check out salesforce.com's historical EPS growth by clicking on this link.
How Is Dilution Impacting salesforce.com's Earnings Per Share? (EPS)
As it happens, we don't know how much the company made or lost three years ago, because we don't have the data. And even focusing only on the last twelve months, we don't have a meaningful growth rate because it made a loss a year ago, too. What we do know is that while it's great to see a profit over the last twelve months, that profit would have been better, on a per-share basis, if the company hadn't needed to issue shares. And so, you can see quite clearly that dilution is influencing shareholder earnings.
In the long term, if salesforce.com's earnings per share can increase, then the share price should too. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. For that reason, you could say that EPS is more important that net income in the long run, assuming the goal is to assess whether a company's share price might grow.
That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.
The Impact Of Unusual Items On Profit
Finally, we should also consider the fact that unusual items boosted salesforce.com's net profit by US$2.3b over the last year.
While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm.
When we analyzed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And, after all, that's exactly what the accounting terminology implies.
We can see that salesforce.com's positive unusual items were quite significant relative to its profit in the year to April 2021. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.
Effects of the Slack Acquisition
Salesforce recently completed their Slack acquisition. The acquisition was priced at US$27.7billion, and will be paid in cash & equity. The reasoning behind the acquisition is that it will help drive more growth for the company and be more competitive against Microsoft's (NASDAQ:MSFT) Teams.
Shareholders may need to be careful, as Slack was just beginning to be profitable as a platform, and experienced significant drops in share price shortly after being listed. The deal will also have some diluting effect on Salesforce shares, and the company may need to bare both the costs of acquisition and operations from Slack for some time.
Our Take On salesforce.com's Profit Performance
To sum it all up, salesforce.com got a nice boost to profit from unusual items - without that, its statutory results would have looked worse.
Profits are forecasted to go down as the company takes on more debt and dilutes shares in the latest acquisition of Slack.
On top of that, the dilution means that its earnings per share performance is worse than its profit performance.
Management needs to make sure their recent moves are fitting in into their long term strategy and not force growth just for the sake of it. Shareholders need to think if they are satisfied both with the financial performance of the company and with the general direction in which they see Salesforce heading.
Considering all this, we'd argue salesforce.com's profits probably give an overly generous impression of its sustainable level of profitability.
If you'd like to know more about salesforce.com as a business, it's important to be aware of any risks it's facing. Every company has risks, and we've spotted 2 warning signs for salesforce.com you should know about.
In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. But there is always more to discover if you are capable of focussing your mind on minutiae. For example, many people consider a high return on equity as an indication of favorable business economics, while others like to 'follow the money' and search out stocks that insiders are buying. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.
Simply Wall St analyst Goran Damchevski and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.