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Salesforce Stock Is at Risk as Other Software Stocks Tank

Ian Bezek

It’s been an eventful week for tech stocks, and the software sector in particular has made headlines. So far, we’ve seen one of the biggest short-term moves out of momentum and growth shares and into value names since at least 2011. Stocks like Alteryx (NYSE:AYX) — the cream of the crop for software as a service names — are down 20% in a few days. Meanwhile, left for dead companies in the old economy, like retail and energy firms, are suddenly surging.

Salesforce Stock Is at Risk as Other Software Stocks Tank

Source: Bjorn Bakstad / Shutterstock.com

So far, Salesforce (NYSE:CRM) has largely avoided getting mauled along with its sector. Salesforce’s stock price is only down about 8% from its 52-week high, which isn’t bad at all given the carnage in many of the other software names. But will CRM stock continue to hold its ground in the coming days and weeks?

Can Salesforce Stock Support its Valuation?

Over the past few years, it hasn’t been difficult to own software companies. If they are growing nicely and generate decent free cash flow, you can generally hold the stock and the share price will rise over time. Sure, there have been bumps along the way, but generally, any dip has been a great buying opportunity.

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We may be entering a new paradigm, however. The drop in software stocks over the past week is one of the worst in years and it comes in isolation. Broader tech stocks including the FAANGs — Facebook (NASDAQ:FB), Apple (NASDAQ:AAPL), Amazon (NASDAQ:AMZN), Netflix (NASDAQ:NFLX), and Alphabet’s (NASDAQ:GOOG, NASDAQ:GOOGL) Google —  aren’t seeing similar declines. Even though Alphabet is under fire from 50 state attorneys general, has avoided a significant selloff. Yet SaaS stocks are getting annihilated.

This leads us to ask if Salesforce stock will fall victim to this trend as well. CRM stock is currently trading for 129 times trailing earnings and 50 times forward earnings. That’s extremely expensive by any measure. With the company’s 22% growth rate, that makes for a PEG ratio well above 2, which many analysts hold as the cutoff for a fast-growing tech company.

Of course, more than a few SaaS companies don’t make accounting profits at all, so Salesforce at least has some real earnings to fall back on. On a price/sales basis, CRM stock is selling for 9x at the moment. That’s expensive, but it’s under the 10x threshold that makes a tech company nosebleed expensive. The 41x price-to-free cash flow metric is also steep, however, particularly given that cash flow growth underwhelmed last quarter.

CRM stock would have to drop a lot in price to become a reasonable buy on a valuation basis.

Has Salesforce’s Investment Profile Changed?

Within the SaaS space, CRM stock was as close to a buy-and-hold-forever pick as you could get. Salesforce has incredible market share in its core CRM business. Once it signs on a customer, it almost never loses them. The time and cost to switch to a different service provider is simply too great. As a result, Salesforce has been able to spend heavily on customer acquisition knowing that most of its new clients will stay on for many years, or decades, producing high-margin predictable cash flows.

As such, you could easily model Salesforce’s value by looking at how fast revenues were growing and watching their margins. It was a fairly easy business to predict so investors got comfortable holding it for the long run.

This may be changing, however. Salesforce has now started to acquire other software companies left and right as it broadens its product offerings. That’s not necessarily a bad thing by any means. But it adds more risk to the profile, as Salesforce could see some of its investments in less core offerings falter and ding the overall valuation.

These aren’t small plays either. Salesforce has purchased MuleSoft for $6.5 billion, ClickSoftware recently for more than $1.3 billion, and — most importantly — Tableau for more than $15 billion. As Salesforce has issued a lot of stock for these deals, it risks significant dilution if these don’t fit in with the core CRM business as much as management hopes. These buys could end up looking great. In the short run, however, with investors questioning software stock valuations, CRM stock looks riskier as investors wait and see if all this mergers and acquisition activity ends up succeeding or not.


My Verdict on CRM Stock

I just don’t see the case for getting involved in CRM stock, yet. It seems there are two ways that things could shake out in the short run. The sector could continue to slide, dragging down Salesforce’s stock price with it. Or the SaaS stocks could stabilize, offering much bigger short-term gains for its peers that have fallen 15%-25% in recent days. If you want to buy the dip, there are more attractive names right now than CRM stock.

With Zscaler (NASDAQ:ZS) down 20% following its earnings report earlier this week, that’s another red flag coming out of the SaaS sector. Salesforce, as one of the longest running SaaS companies, has developed a sterling reputation within the industry. But who knows if that will be tarnished as it integrates all these acquisitions. If Salesforce shows any weakness in its numbers, CRM stock could easily trade down 20% in coming weeks like so many of its peers.

At the time of this writing, Ian Bezek held no positions in any of the aforementioned securities. You can reach him on Twitter at @irbezek.

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