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Salesforce Stock Is a Great Market Barometer

Vince Martin

There’s really only one question when it comes to Salesforce (NYSE:CRM) stock  — what is it worth?

Salesforce Stock Is a Great Market Barometer

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After all, this is a wonderful business. Revenue growth comes in over 20% annually like clockwork. There’s some competition from Microsoft (NASDAQ:MSFT) and Adobe (NASDAQ:ADBE). But Salesforce has established its dominance in CRM. Switching costs are high and acquisitions combined with marketing and commerce cloud offerings provide additional growth drivers.

But CRM stock isn’t cheap. Even raised earnings per share guidance following the company’s fiscal second-quarter report last week still suggests a price-to-earnings multiple of 54x. There is some noise in there due to accounting surrounding the company’s recent acquisitions. Among mature companies, Salesforce stock is up there with Amazon (NASDAQ:AMZN) as perhaps one of the two most dearly valued stocks in the market.

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As a result, I’ve long argued that CRM stock is a key barometer of market sentiment. If the argument really is about valuation, then CRM’s valuation suggests what investors are willing to pay for growth. Right now, after a strong earnings report, that suggests the gains at least in tech may be set to stall out.

CRM Stock Gains Modestly After Earnings

It’s not a good thing that Salesforce stock only gained 2.3% after its Q2 earnings report last week. The report itself was a blowout. Adjusted EPS beat expectations by $0.19. Revenue growth of 22% was a point better than expected.

Full-year guidance was raised on both the top and bottom lines. Both figures were well ahead of the Street, particularly in terms of profits. Analysts on average had expected $2.68 in non-GAAP EPS this year; Salesforce guided for $2.82-$2.84.

And yet CRM stock gained barely 2%. Admittedly, there are two factors at play here. First, investors likely expected a beat. Salesforce hasn’t missed either revenue or profit estimates in at least six years. The so-called “whisper number” likely was higher than Street estimates suggested.

Secondly, as InvestorPlace’s Tyler Craig noted, Salesforce picked the wrong day for a blowout report. Trade war concerns pressured the market in trading on Friday, the day after earnings. And so a 7% after-hours spike turned into a just a 2%+ regular session gain.

Why Salesforce Stock Reflects the Market

Of course, the fact that market worries pressured Salesforce stock is precisely the point. Worried investors are going to question paying 50x+ earnings for any stock. They’re going to look at taking profits when and if they can.

And the longer-term trend in CRM stock certainly suggests there’s a ceiling on valuation at this point. CRM shares snapped back from a Q4 selloff — but have traded essentially sideways since February. That stretch includes three earnings beats. Yet Salesforce stock has shown a consistent, and often bearish, pattern of lower highs and lower lows (if modestly so on both fronts).

The question to ask would be: What’s really changed with the Salesforce story? The answer is essentially nothing. Yet the stock is drifting downward. That’s a market effect, not a Salesforce problem. And it suggests that the days of investors paying continually higher prices for growth have come to an end.

Next Week

For Salesforce stock, that does suggest that investors worried about the market as a whole might want to take profits. Nimble traders might also keep a close eye on CRM stock, shorting any spikes and buying any dips (like the move to $140 earlier this month that quickly reversed).

For investors more broadly, the trading in Salesforce stock only adds to the general sense of caution, if not dread, in the market right now. There are a lot of external worries — and not a lot of cheap stocks out there, particularly in tech.

But I’d also recommend putting a check on the response to CRM stock — which after all, is only one stock. As I noted in “3 Earnings Reports to Watch,” high-flyers Workday (NASDAQ:WDAY) and Veeva Systems (NYSE:VEEV) report this week. Those stocks, too, should provide a barometer on sentiment.

Reactions similar to those that met CRM stock could provide further proof that, as Barron’s wrote in July, software stocks are showing signs of a bubble. And they’d show that after a decade-long bull market, investor focus is returning to valuation over growth at all costs.

As of this writing, Vince Martin held none of the aforementioned securities.

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